A to Z of Trusts

Trusts

Trusts are legal arrangements where one or more trustees are made legally responsible for holding assets. These assets are placed into a trust for the benefit of one or more beneficiaries.

There are many purposes to a trust:

  • Protect & control family assets;
  • Reduce IHT and to;
  • Protect assets for vulnerable individuals (children, individuals who are incapacitated)

A trust consists of a:

  • Settlor (Puts the assets into the trust);
  • Trustee (Legal owners of the assets held in the trust, they manage the assets and decide how its distributed- however it must be in line with the type of trust made) and a;
  • Beneficiary (Individuals who benefit from the assets and the income gained in the trust)

Different Types of Trusts

Bare Trust

These trusts ensure that the assets set aside, will go directly to the beneficiaries stated. The beneficiary holds the absolute right to the assets within the trust and at the age of 18 can legally demand that the assets are transferred to them. Income tax is charged on the interest gained and the income received through any stocks & shares invested. The stated beneficiary is liable for the income tax charged on the income of the trust.

Loan Trusts

These trusts are established by individuals who wish to give themselves an interest free loan, which can be paid back at any time. After 7 years, that trust automatically falls outside of your estate, which means less inheritance tax is paid. The capital and growth is still legally for the beneficiaries but the settlor can choose to take withdrawals to supplement their income. In the event of the death of the settlor, the capital to repay that loan is taken out of the estate, which initially reduces the amount of IHT to be paid also.

Discretionary/Accumulation Trust

Discretionary trusts are those which the legal ownership of the assets is of the trustee, whereby they run the trust with the hindsight of benefitting the beneficiary. Likewise, they have the freedom to decide how to use the trust’s income and how to distribute that income.

Accumulation trusts are when trustees accumulate the income gained and add it to the existing capital in the trust until the beneficiary reaches the legal age in which they are entitled to receive their income/capital from the trust.

In both discretionary trusts and accumulation trusts, income is taxed at the special trust rates, apart from the first £1,000 of trust income, which is known as the ‘standard rate band’. Income that falls within the standard rate band is taxed at lower rates, depending on the nature of the income – as shown in the tables below.

However, if the person who put the assets into the trust (the settlor) has more than one trust, the £1,000 standard rate band is divided by the number of trusts they have. If the settlor has more than 5 trusts, the standard rate band is £200 for each trust.

Trust Income up to £1,000:

Type of Income Tax Rate 2014 to 2015 Tax Year
Rent, trading & savings 20% (Basic Rate)
UK dividends (such as income from stocks & shares) 10% (dividend ordinary rate)

Trust Income over £1,000:

Type of Income Tax Rate 2014 to 2015 Tax Year
Dividends & distributions 37.5% (dividend trust rate)
Other income 45% (trust rate)

Interest in Possession Trust

These trusts give the beneficiary direct ownership of the income received through the trust, less any expenses. Therefore, although the beneficiary receives all the income gained from the trust, they are not entitled to the capital held.

Trustees are responsible for declaring and paying Income Tax on income received by the trust. They do this on a Trust and Estate Tax Return each year.

There are different tax rates depending on the type of income:

Type of Income Tax Rate 2014 to 2015 Tax Year
Rent, trading & savings 20% (Basic Rate)
UK dividends (such as income from stocks & shares) 10% (dividend ordinary rate)

Interest in possession trusts aren’t normally taxed at the special trust rates of tax that apply to non-interest in possession trusts. However some items that are capital in trust law are treated as income for tax purposes when received by trusts. Depending on the type of item they’re either taxed at the trust rate of 45% or the dividend trust rate of 37.5%.

Settlor-Interested Trusts

This trust exists when the settlor benefits from the income/gains held within the trust. These trusts are not types of trust in themselves, but can be any of the above trusts. The settlor is responsible for all the income tax charged but if the trustees receive an income, they must pay the tax on that income.

Chargeable Lifetime Transfers Vs Potentially Exempt Transfers

Depending on the amount gifted/transferred into a trust during the last 7 years, you may have to pay Inheritance Tax (IHT) immediately. If this amount exceeds £325,000, (£650,000 for a married/long term couple) you will have a 20% tax rate to pay, with an additional 6% of the value of trust every 10 years.

Potentially exempt transfers are only liable for tax if the individual making the gift/transfer dies within the 7 years of setting up the trust.