What is a trust and how does it work?

A trust is created to manage assets like money, possessions, properties, and other investments for people. In the UK, different types of trusts can be created and each type is taxed in a different way.

A trust will include 3 entities

  1. Settlor – The one who puts assets into the trust
  2. Trustee – The one who manages the trust (A trust can have one or more trustees)
  3. Beneficiary – The one who benefits from the trust (A trust can have one or more beneficiaries)

Why do people create a trust?

A trust is created for one or more of the following reasons:

  • To manage the family’s assets and keep them safe
  • To help a minor with managing assets until he or she reaches a certain age
  • To help a mentally or physically disabled person with managing assets
  • To pass assets to others when you are still alive
  • To make it easier to distribute assets if you die without a will
  • To reduce inheritance tax levied on the estate

How does a trust work?

When creating a trust, the settlor writes a legally binding document called “Trust Deed”. In this document, the settlor clearly mentions how the assets must be managed or distributed.

Once the trust is created, the trustee becomes the owner of the trust. However, he is legally obligated to administer the trust according to the wishes of the settlor. Depending on the type of trust, a trustee can make some changes. More on that in the next subheading.

Besides administering the assets, the trustee is also responsible for paying any taxes that are due and managing routine affairs related to the trust.

The beneficiaries of a trust can be a single individual, the family or a group of people. They benefit from the income of the trust e.g., rent of a house in the trust. They could also benefit from the capital of the trust e.g., shares in the trust.

Types of Trust

Bare Trust – This type of trust is often created to protect assets for minor children until they reach a certain age. It is held in the name of the trustee who takes care of the assets until the children reach the recommended age.

‘Interest in Possession’ Trust – In this type of trust, the trustee will pass all the income of the trust to the beneficiaries, as and when needed. For example, the income may first pass to the surviving spouse and when the spouse dies, it can pass to the children and so forth.

Discretionary Trust – In this type of trust, the trustee has some freedom to decide how to use the income or capital of the trust. For example, he may pass income to the beneficiaries if or when he feels that they are capable of managing them.

Accumulation Trust – This is similar to discretionary trust where the trustee has some freedom in deciding how to use the trust. In addition, in this type of trust, the trustee is allowed to accumulate income within the trust and then add it to the capital of the trust.

Mixed Trust – It is a combination of two or more types of trust and each part of the trust is taxed according to its type.

Settlor-Interested Trust – This type of trust is created for the settlor or for the spouse or civil partner of the settlor. For example, a settlor may realise that they can no longer work and earn money because of an illness. In this case, they can create a trust to care for their future needs.

Should a trust be registered?

A trust must be registered with HMRC if it is liable for

  • Capital Gains Tax
  • Inheritance Tax
  • Income Tax
  • Stamp Duty Reserve Tax

A trust must also be registered if you want to claim tax relief.

Please contact Aristone Solicitors if you have queries about the taxes levied on each type of trust. We can also offer professional assistance in registering a trust.

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