Most people spend a lifetime building up savings, property and other assets. It is natural to want control over what happens to those assets, both during your lifetime and after death. A trust is one of the most flexible tools available in estate planning to help achieve that.
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What Is a Trust?
A trust is a legal arrangement in which one person (the settlor) transfers assets to another person or persons (the trustees) to hold and manage for the benefit of chosen individuals (the beneficiaries). The trustees become the legal owners of the assets, but they are bound to deal with them in accordance with the terms of the trust, not for their own personal benefit.
A trust is usually created by a written document called a trust deed, or it can be established within a will (known as a will trust). The terms set out who the trustees and beneficiaries are, and the rules governing how the trust assets are to be managed and distributed.
Why Use a Trust?
Trusts have become increasingly popular in estate planning in recent years. Rising property values, the freezing of the inheritance tax nil rate band at £325,000 since 2009, and growing concerns about the cost of long-term care have all contributed to more families considering trusts as part of their planning. Trusts feature prominently in estate planning for several practical reasons.
Protecting vulnerable beneficiaries. Where a beneficiary may not be able to manage money independently for example, a young grandchild or a family member with a disability, a trust allows trustees to manage funds on their behalf and release money as and when appropriate.
Controlling distribution. A trust can provide that assets are paid out at certain ages or milestones, or that income is paid regularly while the capital is preserved for the longer term.
Providing for a surviving spouse while preserving the inheritance for children. This is particularly relevant in second marriages. A life interest trust can allow a surviving spouse to live in a property or receive income for the rest of their life, with the underlying assets ultimately passing to the settlor’s children.
Potential protection from care fees. Local authorities have powers under the Care Act 2014 to investigate whether assets have been deliberately given away or placed in trust to avoid paying for care. If a trust is created with the primary intention of avoiding care fees, the local authority may treat those assets as if the settlor still owns them. However, where a trust is established for genuine broader planning purposes, it can form part of a sensible strategy. Professional advice is essential.
Nil Rate Band Discretionary Trusts and Inheritance Tax
One of the most widely used trusts in estate planning is the nil rate band discretionary trust. Understanding how it works requires a brief explanation of the inheritance tax framework.
Every individual has a nil rate band (currently £325,000) below which no inheritance tax is payable on their estate. Assets exceeding this threshold are generally taxed at 40%. Married couples and civil partners can also benefit from the transferable nil rate band, meaning that on the second death, up to £650,000 tax free allowance may be available.
A nil rate band discretionary trust involves the settlor transferring assets up to the value of the nil rate band into a discretionary trust during their lifetime. Because the transfer falls within the nil rate band, no inheritance tax is payable at the point of transfer. Critically, provided the settlor survives for seven years after making the transfer, the gift becomes fully exempt and falls out of their estate entirely for inheritance tax purposes.
The discretionary element gives trustees flexibility to distribute assets among a class of beneficiaries (typically children and grandchildren) according to changing family circumstances. This can be particularly valuable where the settlor’s family situation may evolve over time.
Note that this tax planning will not be effective if the settlor includes himself as a potential beneficiary of the trust and be aware that there may be small periodic and exit tax charges in future if the fund grows in value.
For individuals in good health with assets exceeding the nil rate band, establishing such a trust well in advance can be an effective means of reducing the eventual inheritance tax liability on their estate. The key consideration is time: the seven-year survival period is essential for the full tax benefit to crystallise.
Ring-fencing Trust Assets
It is important that trust assets are kept entirely separate from the settlor’s personal finances. A recommended course of action is for trustees to open a dedicated trust bank account to hold the funds, ensuring clear records are maintained and the trust’s independence is preserved.
Choosing Trustees
Trustees can be family members, friends, or professionals such as solicitors. Trusteeship carries legal responsibilities: trustees must act in the best interests of the beneficiaries, keep proper records, and comply with tax reporting obligations to HMRC. Selecting appropriate trustees is as important as establishing the trust itself.
Seeking Advice
Every family’s circumstances are different. A solicitor experienced in estate planning can help you assess whether a trust is appropriate, select the right structure, and ensure it is properly drafted and legally effective. Planning ahead provides the best opportunity to ensure your wishes are carried out and your family is provided for.