The Main Types Of Trusts And Their Uses

Question 1

Briefly explain what a trust is

Answer 1

1. Definition:
   A trust is a legal arrangement where a person (the settlor) transfers property to another person (the trustee), who manages it for the benefit of specific people (the beneficiaries).
2. How a Trust is Created:
   A. During the settlor’s lifetime – through a trust deed.
   B. After the settlor’s death – through a will or intestacy laws (if there is no will).
3. Trustee Responsibilities:
   Trustees must manage trust property in the best interest of beneficiaries, following the Trustees Act 2000, unless the trust deed says otherwise.

Question 2

What are the four main types of trust?

Answer 2

1. A bare trust
2. An interest in possession trust.
3. A charitable trust.
4. A discretionary trust.

Question 3

What is a bare trust?

Answer 3

1. Definition:
   A. A Bare Trust (also called an Absolute Trust) is a simple trust where the trustee holds assets legally, but the beneficiary owns them absolutely.
   B. Trustee is the LEGAL OWNER but, beneficiary is the ABSOLUTE OWNER
   C. Only the beneficiary has the absolute rights to the assets, any income or gains.
2. Tax Treatment:
   A. The income and capital gains (when assets are sold for profit) from the trust are taxed as the beneficiary’s, not the trustee’s.
   B. I.e. beneficiary pay tax on any profits rather than the trustee.
3. Common Use:
   A. Often used for children, as they cannot manage assets until they reach adulthood.

Question 4

What is “an interest in possession trust”?

Answer 4

1. Definition:
   A. Also called a Life Interest Trust.
   B. This trust gives one person (Party A) the right to benefit from the assets (e.g., receive income or live in a property) for their lifetime. (Until they die)
2. How It Works:
   A. Party A has an “interest in possession” until they die.
   B. After Party A’s death, the assets pass to the remainderman (the ultimate beneficiary).
3. Common Use:
   A. Often used in wills to support a spouse/partner while ensuring assets ultimately go to chosen beneficiaries, protecting them from claims (e.g., from a new spouse or creditors).

Question 5

What is a charitable trust?

Answer 5

1. Definition:
   A trust set up for charitable purposes, benefiting the public rather than specific individuals.
2. Common Purposes:
   A. Relief of poverty
   B. Advancement of religion
   C. Advancement of education
   D. Other community-benefiting causes
3. Special Features:
   A. Enjoys tax benefits as a recognized charity. I.e. tax exemptions and reliefs
   B. Exemption from Income Tax and Capital Gains Tax – trust does not pay tax on income (e.g., rental income, investment returns) or capital gains from selling assets, as long as the funds are used for charitable purposes.
   C. Inheritance Tax (IHT) Relief – Assets given to a charitable trust are usually exempt from Inheritance Tax.
   D. Must operate exclusively for charitable purposes.

Question 6

What is a discretionary trust?

Answer 6

1. Definition:
   A trust where trustees have full discretion over how, when, and to whom trust income or assets are distributed among the beneficiaries.
2. Key Features:
   A. Trustees decide which beneficiaries receive assets and when.
   B. Beneficiaries do not have an automatic right to the assets.
   C. Assets legally belong to the trust, and trustees manage them.
3. Common Uses:
   A. Providing for children and future grandchildren (e.g., releasing funds at a set age).
   B. Supporting beneficiaries based on need, rather than fixed entitlements.
   C. Used in wills to give flexibility over inheritance.
4. Inheritance Tax (IHT) Benefits/ avoid IHT liability:
   A. Assets in the trust DO NOT form part of the beneficiary’s estate, reducing Inheritance Tax (IHT) liability.
   B. Why? - Beneficiary DOES NOT have absolute entitlement to the assets therefore, assets placed in this trust are not treated for IHT purposes.
5. Settlor can leave a “letter of wishes” that can guide trustees on how to distribute assets while ensuring tax efficiency.
6. The main instruction in a “letter of wishes” is normally that the beneficiary sufficiently provided for until their death.

Question 7

Differences between discretionary trust vs all other trusts

Answer 7

1. In a discretionary trust the trustee has the responsibility on the management of assets in the trust.
2. For other trusts - how trustee can act with regard to the assets is very strictly defined.
3. In discretionary trust - trustees use their discretion to decide which (if any) of the intended beneficiaries should receive income or capital from the trust