Family Trust

What is a Family Trust?

A family trust, also known as a discretionary trust, is a legal arrangement in which a settlor transfers assets to trustees. These trustees hold and manage the assets for the benefit of the beneficiaries, typically family members. The settlor defines the terms of the trust in a legal document known as a trust deed. This document outlines how the trust should be managed and how the benefits should be distributed.

Types of Family Trusts

There are several types of family trusts, each with specific purposes and advantages:

1. Discretionary Trusts: These trusts allow trustees to decide how the trust’s income and capital are distributed among the beneficiaries. This type of trust offers flexibility, allowing trustees to respond to beneficiary circumstances changes.
2. Bare Trusts: Bare trusts, also known as simple trusts, are straightforward. The beneficiaries have an immediate and absolute right to the trust’s assets and income. Bare trusts are often used to hold assets for minors until they reach adulthood.
3. Interest in Possession Trusts: In these trusts, one or more beneficiaries have the right to receive the income from the trust, often for life. After their deaths, the capital passes to other beneficiaries. This type of trust is commonly used to provide for a spouse or partner while preserving the capital for children.
4. Accumulation and Maintenance Trusts: These trusts are used to provide for children’s future needs, such as education or starting a business. The trustees can accumulate income within the trust and distribute it at their discretion.
5. Life Interest Trusts: Similar to interest in possession trusts, these are often used in wills to ensure a spouse or partner is provided for while preserving the capital for other beneficiaries.

Benefits of Family Trusts

Family trusts offer a range of benefits, making them an attractive option for managing and protecting family wealth:

1. Asset Protection: Family trusts can protect assets from creditors, divorce settlements, and other claims. By placing assets in a trust, they are no longer considered part of an individual’s estate, offering a layer of protection.
2. Tax Planning: Trusts can mitigate inheritance tax (IHT) and other taxes. For example, assets placed in a trust more than seven years before the settlor’s death may not be subject to IHT. Trusts can also provide income tax and capital gains tax planning opportunities.
3. Control and Flexibility: Trusts allow settlors to maintain control over how and when beneficiaries receive their inheritance. This is particularly useful for ensuring that young or vulnerable beneficiaries are provided for appropriately.
4. Continuity: Trusts provide a mechanism for managing family wealth across generations. They can ensure that assets are preserved and used in line with the settlor’s wishes, even after their death.
5. Privacy: Trusts are private arrangements that do not become public documents, unlike wills. This can be important for families wishing to maintain confidentiality regarding their financial affairs.

Setting Up a Family Trust

Setting up a family trust involves several key steps:

1. Identifying the Purpose: The first step is to clearly define the purpose of the trust. This will guide the selection of the appropriate type of trust and the drafting of the trust deed.
2. Selecting Trustees: Trustees play a critical role in managing the trust. It is important to choose individuals or professional trustees who are trustworthy, competent, and capable of managing the trust in the best interests of the beneficiaries.
3. Drafting the Trust Deed: The trust deed is a legal document that sets out the terms of the trust. It should be drafted by a solicitor to ensure it meets legal requirements and accurately reflects the settlor’s intentions.
4. Transferring Assets: The settlor must transfer assets to the trust. This can include cash, investments, property, and other valuable assets.
5. Registration and Compliance: Trusts must comply with legal and regulatory requirements, including registration with HM Revenue and Customs (HMRC) and adherence to tax obligations.

Trustees' Responsibilities

Trustees have significant responsibilities and must act in accordance with the terms of the trust deed and the law. Their duties include:

1. Fiduciary Duty: Trustees have a fiduciary duty to act in the best interests of the beneficiaries. They must manage the trust’s assets prudently and avoid conflicts of interest.
2. Record-Keeping: Trustees must keep accurate records of the trust’s assets, income, and expenses and provide regular reports to beneficiaries.
3. Tax Compliance: Trustees ensure the trust complies with tax obligations, including filing tax returns and paying any due taxes.
4. Investment Management: Trustees must invest the trust’s assets to balance risk and return, considering the needs of current and future beneficiaries.
5. Distribution of Benefits: Trustees must distribute benefits to beneficiaries in accordance with the trust deed. In discretionary trusts, this involves deciding who receives benefits and when.

Taxation of Family Trusts

The taxation of family trusts can be complex, and it is essential to understand the implications:

1. Inheritance Tax (IHT): Assets transferred into a trust may be subject to IHT. However, there are exemptions and reliefs available. For example, the nil-rate band and the seven-year rule can be utilised to minimise IHT.
2. Income Tax: Trusts are subject to income tax on the income they generate. The rate depends on the type of trust and the nature of the income. Discretionary trusts are subject to the highest rates, while bare trusts are taxed at the beneficiary’s rate.
3. Capital Gains Tax (CGT): Trusts are subject to CGT on asset disposals. Trustees are entitled to an annual exemption, but gains above this threshold are taxed at the applicable rate.
4. Trust Registration Service (TRS): Trusts must be registered with HMRC’s Trust Registration Service, which requires detailed information about the trust and its beneficiaries.

Potential Pitfalls and Considerations

While family trusts offer many benefits, there are potential pitfalls to be aware of:

1. Complexity and Costs: Setting up and managing a trust can be complex and costly. Professional advice and ongoing management are often required, which can incur significant fees.
2. Tax Implications: Trusts can have complex tax implications, and it is essential to seek expert advice to ensure tax efficiency and compliance.
3. Loss of Control: Once assets are transferred to a trust, the settlor no longer has control over them. Trustees are responsible for managing the assets in accordance with the trust deed.
4. Legal and Regulatory Requirements: Trusts must comply with a range of legal and regulatory requirements, and failure to do so can result in penalties and other consequences.

Case Study: A Practical Example

To illustrate the practical application of a family trust, consider the following case study:

Mr. and Mrs. Smith wish to ensure that their wealth is preserved for their children and grandchildren while providing for their own needs during their lifetime. They decide to set up a discretionary family trust.

1. Purpose: The primary purpose of the trust is to provide for the education and future needs of their grandchildren.
2. Trustees: Mr. and Mrs. Smith appoint their solicitor and a trusted family friend as trustees to manage the trust.
3. Trust Deed: The trust deed specifies that the trustees have discretion to distribute income and capital to the beneficiaries. It also outlines provisions for the trustees to provide financial support for Mr. and Mrs. Smith if needed.
4. Assets: The Smiths transfer a portfolio of investments and a rental property into the trust.
5. Management: The trustees manage the trust’s assets, ensuring that the rental income is used to support the beneficiaries’ education and other needs.
6. Tax Planning: The trustees work with a tax advisor to ensure that the trust is tax-efficient, utilising available exemptions and reliefs.

By setting up the trust, the Smiths achieve their goal of preserving their wealth for future generations while retaining the flexibility to provide for their own needs.

Conclusion

Family trusts are powerful tools for managing and protecting family wealth. They offer numerous benefits, including asset protection, tax efficiency, and control over asset distribution. However, setting up and managing a trust requires careful planning, expert advice, and ongoing management to ensure compliance and effectiveness.

At DLS Solicitors, we are committed to providing expert guidance and support to families considering setting up a trust. Our team of experienced solicitors can help you navigate the complexities of family trusts, ensuring your wealth is managed and protected in line with your wishes.

If you are considering a family trust or need advice on an existing trust, please do not hesitate to contact us. We are here to help you secure your family’s financial future.