IF there’s an area of financial
planning that is often
misunderstood, then it is trusts –
although it can be argued that the
recent budget changes have created
equal amounts of confusion on
pensions too!
I’d even go so far as to say that
there are many financial advisers who
don’t understand trusts as they should.
However, trusts are, and will remain,
a key financial planning tool. Wealthy
families understand the power of trusts
to protect the family money across
the generations, but
ordinary people like
you and me can also
bene t from using
trusts in certain
circumstances.
The purpose of
this article is to
(hopefully!) clarify
things for you and give you what you
need to know about trusts for the vast
majority of cases, and then the things
you need to do if you’re considering
setting up a trust for your own needs.
1. What, who and how
A trust arrangement is a separate legal
entity. So the courts and HMRC see
a trust as a distinct body under law.
There are specific laws pertaining to
trusts, the Trustee Act 2000 being the main
one, and a trust has
tax allowances and
rules which only apply
to trusts.
For the purposes
of this article, think
of a trust as a bucket.
Into the box you can
place things, pretty
much anything,
such as investments,
property, cash, etc. On
the bucket are some
written instructions as
to how the things in
the bucket should be looked after, and
also instructions as to when the bucket
should be opened, and to whom the
contents should be distributed.
There are three parties involved
in setting up and running a trust: (1)
settlor – sets up the trust and gives the
instructions as to how it should be run in the future; (2) trustees – look after
the trust and follow the settlor’s wishes
within the laws pertaining to trusts; and
(3) beneficiaries – those who receive
the bene t of the trust property, the
things in the bucket.
All trusts are set up via a written
trust deed. This can either be stand-
alone or part of someone’s will.
The document needs to be signed,
witnessed and dated in order to be
valid.
2. Powers and
duties of trustees
Trustees have certain powers and
duties which they are bound by, under law. Here are the main ones in
summary:
Power of investment – unless the
trust deed specifically limits a trustee,
he (or she) can “make any kind of
investment that he could make if he
were absolutely entitled to the assets of
the trust”. This is important as it opens
up pretty much any kind of investment
for the trust to hold. This power comes
with duties though:
(a) Duty to exercise
skill and care – this
takes account of a
trustee’s professional
status, so I would be
held more to account
given my professional
adviser status than an
ordinary lay trustee.
(b) Duty to take
account of standard
investment criteria –
these criteria, when it comes to trusts,
are to make sure any
investment chosen
is suitable and to make sure the money is sufficiently
diversified – that is, spread around.
(c) Duty to keep investment under
review – trustees should have regular
meetings to make sure the chosen
investments continue to be the best
choice for the trust.
(d) Duty to take advice – if a trustee
is not a qualified adviser, he or she
should seek advice from an expert as
to the best course of action.
(e) Power to delegate – a trustee can
delegate some of his or her powers
to a third party if it is in the best
interests of the trust. This might
mean instructing a discretionary fund manager to look after the day-to-day
management of the funds. Obviously
the delegate should be qualified and
able to do the job. The trustee remains
responsible for the actions of the
delegate.
(f) Duty to ensure fairness between
beneficiaries – if there is more than
one beneficiary, then the trustees
are bound to make sure they are
both considered equally. This type
of scenario is fairly common where
an older man or woman has died
and set up a trust in their will.
The
surviving spouse will get an income
produced by the trust investments and their
children eventually
get the capital when
the surviving spouse
dies. The surviving
spouse is called the
Life Tenant of the
trust, and can never
touch the capital, but only the income
from it. Likewise the
children, called the
“remaindermen”, get
nothing at all until the
surviving spouse dies.
Managing investments
in this case is tricky because the
trustees cannot favour one class
of beneficiary over another.
There
have been high-profile cases where
beneficiaries have successfully sued
trustees for getting this wrong.
(g) Duty to take account of the
settlor’s wishes – this might seem
obvious but a settlor can write a “side
letter” to the trustees giving them
some guidance as to his thinking
when setting up the trust, hopefully to
make their job easier. When making
their decisions, trustees must always
consider what the settlor would have
wanted when he set up the trust.
(h) Duty not to sit on cash – there
have been many cases where trustees
were hesitant to invest, and in being
so missed out on a rising stock
market. Unless money is needed by a beneficiary in the short term, any
money held by the trustees should
generally be invested.
(i) Duty to take account of tax
considerations – again, this should
go without saying, but trusts have
complicated tax rules specific to them,
so trustees need to know what they are
doing.
All these powers and duties are
binding on the trustees, and are not to
be taken lightly.
3. Benefits of trusts
Surely there must be some clear
benefits of trusts, or are they just a
series of over-complicated rules, duties, powers and taxation quirks? With this
in mind I have listed below some key
benefits of trusts and how they might
benefit an individual:
(a) Trusts enable specific instructions
to be carried out within a legal
framework. A well-worded trust
can be used to execute the settlor’s
instructions, no matter how specific or
vague. Conversely, a badly-worded trust
can cause the trustees problems. If you have a specific set of instructions
you want carried out at a specific time,
involving specific people, a trust can
achieve that for you.
(b) Trusts are not part
of your estate. This
means that property
inside a trust does not
have anything to do
with the rest of the
estate on the death of
the settlor. This can
save inheritance tax if planned far enough
ahead, and can get
money to the people
who need it quickly
after the death of the settlor, without
waiting for probate to
be granted.
(c) Trusts can offer tax savings.
Moving money into a trust can help
you organise money tax-efficiently.
Inheritance tax is the obvious benefit,
but there are other potential tax savings
that can be received in addition to this.
(d) Trusts can ring-fence money
against outside influences. For
example, imagine one of your children
is married and you leave “family”
money to him or her. If the offspring
subsequently gets divorced, some of
that family money could leave with the
ex-wife or husband. Or maybe that
spouse goes bankrupt – money in a
trust could be protected from that,
depending on the type of trust and its
terms.
(e) Trusts can be used to protect
money against means-testing. Care is
needed here, but one example where
trusts can be very useful is if someone
suffers a personal injury and receives a
payment of monies as compensation.
In some circumstances this could
scupper their receipt of certain
benefits. Trusts can be used to protect
benefits in the right circumstances.
We have now looked at what trusts
are and how they work. We’ve also
considered the powers and duties of
trustees, and have taken a very quick
look at some of the benefits. My next
article will focus on what you need to
do if you are a trustee, or are thinking
of setting up a trust, and the key
considerations you will need to take
before setting anything up.