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Trusts in estate planning

What are trusts and how are they used in estate planning? Here are a few things to consider when you’re discussing your Will with a Will writer or solicitor.

There are different types of trust and they’re used for different reasons. Below is a basic guide to the concept of trusts and why you might want to use one.

If you think a trust might be a good idea, book an appointment with Bristol Wills & Estate Planning to discuss your requirements. Or search Google for will writers and will writing solicitors near me.

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2

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DISCLAIMER: To the best of our knowledge, the information below as accurate at the time of publication in 2024. The information below should be treated as a starting point for further discussion with a suitably qualified professional. It is a basic overview of trusts, not a comprehensive guide. You should seek expert advice before taking any action in relation to trust planning.

Do I need a trust?

A trust is recommended if you do not wish someone to inherit outright, known as inheriting “absolutely” from you.

The people who inherit from your estate are known as the beneficiaries. If you just have a basic Will, or you don’t make a Will at all, the beneficiaries will get the money or property directly.

Of course, it will take a bit of time for this to happen, because the estate administration process can take several months (sometimes even years if it’s complicated).

When estate administration is complete, beneficiaries receive money straight into their bank account or are handed the keys to property and other possessions.

In certain circumstances, however, this may not be a good time for them to inherit. A trust can protect their inheritance until such time as it is.

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What is a trust anyway?

The definition of a trust, according to the Collins English Dictionary, is:

“A trust is a financial arrangement in which a group of people or an organization keeps and invests money for someone.”

To flesh this out, the “group of people who keep and invest” an asset (it doesn’t have to be money) are called the trustees. In fact, they are the legal owners. The dictionary definition says “group” because you need at least two if you’re using friends and family members.

The trustees are the legal owners but the assets are not theirs to keep forever. They only hold on to the assets of someone else. That someone, or multiple people, are called the beneficiaries of the trust. The beneficiaries and the trustees can be the same people.

So you can think of trustees as being wise custodians of an asset (e.g. money or a property), taking good care of it for someone else.

Precisely how they do this, and for how long, is set out in the the trust deed. The person who sets up the trust, or who includes a trust in their will, may also write some accompanying instructions in plain English in a separate letter of wishes.

The power of this approach is that the beneficiaries have access to an asset, e.g. money, but without owning it themselves.

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What are the common reasons for using a trust?

The main reason is that nobody has a crystal ball! You simply don’t know what circumstances a beneficiary will find themselves in at the time they inherit from you.

For this reason alone, a trust might be a good idea.

But even though none of us can predict the future with certainty, you might be able to spot some warning signs, such as:

Beneficiary in a rocky marriage

The latest data from the ONS (Office for National Statistics) shows that one in five couples married in 2011 got divorced before their tenth wedding anniversary. And if one of your beneficiaries is going through a divorce, anything they inherited outright would fall prey to a financial settlement. Potentially, they could lose up to half of what they’d just inherited.

Beneficiary goes bankrupt

A beneficiary who goes bankrupt stands a good chance of losing everything to creditors, including everything they’d inherited. This could be the result of overspending or a bad business decision.

Beneficiary bad at managing money

A beneficiary may not go completely bankrupt. But what if they spend more than they earn? Perhaps they’re suffering from an addiction. Inheriting potentially a large sum of money might not serve them well.

Beneficiary classed as vulnerable

Somebody who is vulnerable, whether mentally or physically or both, may be receiving state benefits. That person could well lose those benefits if they inherit money. Plus, if they need help managing money, this would be easier to do in a controlled fashion via a trust than if they received thor inheritance outright.

Beneficiary needs care fees

A beneficiary going into care may only happen years after your death, if at all. But with care fees now averaging £800 for residential care and nearly £1,100 for nursing care, according to Age UK, it’s a big drain on finances for any self-funder. Those figures are for the average of the whole of the UK. I think it’s a safe bet that care fees in Bristol are higher than this.

Beneficiary pays more inheritance tax

Your children are doing well in life – congratulations to them, and to you for your excellent parenting. But what about the grandchildren? If your children inherit a large sum from you, that will swell the size of their estate. As a result, they could pay more inheritance tax. And grandchildren will inherit less. All things you can avoid using trusts.

Beneficiary moves abroad

It’s estimated that around 5.5 million British-born people live overseas. If your beneficiary is living abroad at the time they inherit, they could be taxed on their inheritance by the country they live in. Whilst your children may live in the UK now, they could move abroad in the future.

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What is “sideways disinheritance” and why is it a problem?

So-called sideways disinheritance is often mentioned as a good reason for using a trust. But what is it?

First, do you know anyone who was divorced or widowed and has children? It’s pretty common. That person might be in a new relationship or has since remarried.

There are two consequences of this for a Will:

  1. Marriage typically revokes an existing Will, so remarrying takes you back to the statutory laws of intestacy. The exception is if your existing will is written in anticipation of divorce but this is rare.
  2. Anyone can change their Will at any time. Some people who meet new partners might favour them in their Wills, particularly if they stay together a long time.

Why is this a problem? Those children from the first relationship can lose out. A trust ensures they inherit some, or perhaps all, of an estate.

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What kinds of trust are there?

There are lots of different names for trusts, which is why it can be very confusing. There are both legal names for trusts and “product names” that will writers and solicitors use to describe certain types.

Ultimately, the choice of trust depends a lot on your circumstances and what you want to achieve. To find out which trust is right for you, if any, you should talk to an expert who can advise you which is right for you.

That being said, there’s one easy question you can ask to distinguish between different trusts so you know what you’re getting:

Is the trust in a Will?

If the answer is Yes

A trust in a Will is literally written into the Will document itself. Your Will will look like any other Will, with appointment of executors and other standard clauses. It will all be contained in one document. You might also have a separate document called a Letter of Wishes or Memorandum of Wishes, but this still relates to the Will.

A trust in a Will only comes into effect after death! That’s because it’s in a Will, and Wills are only read after you die. In other words, there is no protection until you die. The trust is only formalised when you die and until then it is just words on a page.

If the answer is No

If the trust is not in a will, it’s a separate entity. It is literally a different document. This means it’s a “lifetime trust”, meaning that you set it up during your lifetime.

Everything that happens with a trust, including the appointment of trustees, happens while you’re alive. This means that the trust protects the asset held in it from the word go.

Therefore it can protect assets against things that might happen to you during your lifetime to a certain extent, and definitely after your death.

A lifetime trust is a completely separate document from your Will, even though you may well get them at the same time.

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How much do trusts cost?

To give you a ballpark idea of how much you’ll pay for a trust.

Trusts in Wills

These types of trust wills from a will writer or solicitor are typically a bit more expensive than a simple will. Typically, they’ll cost in the low hundreds of pounds. After death, there is typically more expense because the trust needs to be formalised as part of the estate administration process.

Lifetime trusts

There is a lot more involved in producing lifetime trusts, including money laundering checks on the parties involved. For that reason, the price is typically several thousand pounds. There is no cost to formalise the trust after death, because it’s already been set up, but there may be ongoing costs. If you’ve appointed a professional trustee, they’ll charge an annual fee. And some firms charge for producing annual minutes.

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Can a trust avoid probate?

Yes, a lifetime trust can avoid probate. That is the type of trust you set up in your lifetime.

Probate is the term normally used for “estate administration” – that’s when executors apply for a grand of probate, gather in assets by writing to banks, and finally distribute the assets to beneficiaries.

This process can take a long time – at least several months, if not longer.

Whilst this is dragging on, you cannot sell a property. That’s why it’s useful to have a property in trust, because it doesn’t pass via a Will. It can be sold straight away by the trustees.

Remember that this only applies to lifetime trusts that are already up and running. A trust in a will cannot help because a trust in a will is only formalised after death, and that’s when estate adminstration goes into full swing.

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Are trusts a new idea?

No! In fact, trusts were used in England during the time of the Crusades.

And the concept of a trust goes even further back than that. It was mentioned in the Iliad by the poet Homer around the eighth century B.C.

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Are trusts a legal loophole?

It’s odd when trusts are described like this in the media because a trust is a perfectly legal method of ownership.

Trusts are enshrined in English law, being covered by such Acts of Parliament as the Trustee Act 1925, Trustee Investments Act 1961, and Recognition of Trusts Act 1987.

The most common example of a trust is when a person dies leaving a gift to someone who is under 18. If that happens, a trust is automatically created to hold the money until they come of age.

Frequently, people will specify a higher inheritance age in a Will – for example, to ensure that children do not inherit before the age of 21. If so, then the money is held in trust for them.

Sometimes trusts do hit the headlines for various reasons, but those reasons have nothing to do with the underlying concept and legal use.

That’s not to say that trusts have never been used for nefarious purposes, such as money laundering. These are the examples that make the news headlines because they are so extreme and unusual.

But the phrase “legal loophole” implies dishonest intentions. And just as you can drive a car without speeding, so can you use a trust for perfectly legal and honest reasons. And that’s how the vast majority of trusts are used.

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Are trusts only for rich people?

Trusts are certainly used by rich people. That’s why they tend to hit make headlines in the media.

Various members of the aristocracy, MPs and members of the House of Lords are known to have used trusts. The most famous example is probably the Duke of Westminster.

However, trusts in Wills are very common amongst ordinary members of the public like you and me.

Trusts set up in lifetime are perhaps less common. That’s probably because they are a lot more expensive. But it is not difficult to get them and a lot of ordinary people use them too.

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Can a trust help to avoid inheritance tax?

You should definitely take advice before deciding whether or not a trust is right for you.

In certain circumstances, trusts can help to mitigate an inheritance tax bill. But it’s important to be clear about two very different situations:

1. Can I use trusts to avoid inheritance tax on my estate?

Forget trusts just for a moment. Think about regular gifts that you make in your lifetime. If you give something away, then after 7 years it will be outside or your estate for inheritance tax.

The same applies if you gift into trust, so long as you are not a beneficiary of that trust and don’t use it. In those circumstances, the gift could be outside of your estate for inheritance tax after 7 years.

Let’s say grandparents have money they don’t need access to, and they decide to put it in trust for their grandchildren.

If they put the money in trust, it will be outside of their estate after 7 years. (And it stops grandchildren from wasting it if they inherit it outright).

So if you have no need of an asset and you’re not going to use it, putting it in trust might be an option.

But there are two things to be aware of:

  1. Trusts have entry charges if you put in more than the threshold amount, currently £325,000.
  2. There could be other ongoing charges (“periodic” charges) every 10 years and potentially exit charges too so it’s vital to take advice on the tax implications.

When do trusts NOT help me avoid inheritance tax on my estate?

You will not avoid inheritance tax on your own house simply by putting it in trust and continuing to live in it.

Unless, that is, you pay a full market rent, which has to be reviewed regularly.

This might seem odd until you consider that inheritance tax rules focus on giving things away. You haven’t really given away your house if you continue to live in it (without paying rent) because you are still enjoying the benefit of it.

This has a name. HMRC calls it a Gift with Reservation of benefit.

There’s nothing to stop you from putting your own house in trust. In some circumtances, this might be a good idea. But unless you pay a full market rent, it won’t help you avoid inheritance tax.

2. Using trusts to avoid inheritance tax on someone else’s estate

There are two ways that you can use trusts to help other people avoid inheritance tax.

i. Avoiding IHT for your children and grandchildren

If you inherit something, it will form part of your estate. When you die and pass it on to children, it will form part of your children’s estates and so on.

If each estate is subject to inheritance tax, then the same asset is taxed over and over again with each successive generation. This is often called “generational inheritance tax”. In other words, children are landed with an inheritance tax just because their parents have been successful and generous!

Now think about the opposite scenario. If you never inherit something, it will never be subject to inheritance tax. This is the principle behind planning using trusts.

If your inheritance goes into a trust and you are a beneficiary of that trust, you will still be able to access the money you’re entitled to.

But those funds in the trust will never form part of your estate. So when you die, your children won’t inherit those assets directly. Instead, they’ll be beneficiaries of the trust too.

Trusts last for 125 years, so there’s plenty of scope for prudent planning that will benefit successive generations.

ii. Avoiding IHT for your unmarried partner

Unmarried couples aren’t treated the same in law as married couples and civil partners.

Whereas married couples and civil partners can transfer their inheritance tax allowances (nil rate bands) to each other, unmarried couples cannot.

Therefore, unmarried couples are stuck with the same allowances as single people. This means that after one partner dies, the survivor could end up with everything but only have an allowance of £325,000 (plus an extra £175,000 if they’re passing a main residence to children or other descendants.)

This can easily be solved with a trust. If both partners have a trust in their will, the trust can hold the deceased’s assets. The survivor never inherits those assets, so they don’t form part of their estate.

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Can a trust prevent someone making a claim against my estate?

A discretionary trust could act as a effective barrier against someone making a claim against your estate under the Inheritance (Provision for Family and Dependants) Act 1975, for example an ex-spouse or one of your children.

It would not stop someone making a claim under the Act, because that’s their right under the law. But it could prevent a claim being successful.

That’s because under a discretionary trust, there is no outright guarantee that anyone named as a beneficiary should benefit from the trust. It is down to the discretion of the trustees, hence the name.

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How to use this information

This article represents our understanding of the law and tax rules at the time it was published (2024). It provides general information and is intended as a starting point for further research and conversations. Please seek competent professional advice before taking any action in relation to Wills and estate planning. Bristol Wills & Estate Planning Ltd is not liable for any errors or omissions on this page or for any actions taken as a result of reading this information.

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