What is a Trust in a Will?
A trust is a legal agreement that property or assets are to be managed by a person or group of people, known as the trustees, on behalf of another person or group of people, known as the beneficiaries. It sets out specific conditions in respect of how and when assets are to be managed and distributed and comes into force upon the death of the testator (the writer of the Will).
What are the benefits of a Will trust?
The main purpose of a trust is to make the benefits of the deceased’s assets including income, capital, and property available to individuals without them having legal ownership of the asset. You would set up a trust to:
- Potentially reduce inheritance tax liability.
- Protect your estate against potential future care home fees
- Provide additional protection for your assets to ensure they are not misdirected after your death. For example, ensuring your children still inherit your assets if your spouse remarries or has children of their own.
- Ensure provision for someone who would be unable to manage their inheritance for themselves. For example, a vulnerable adult or a child under the age of 18.
What are the disadvantages of a trust?
There will be different disadvantages depending on the type of trust being used and your individual circumstances. Your Will writer or solicitor should advise you of what those disadvantages are before creating the trust in your Will. Often one of the disadvantages of a trust is an increased inheritance tax liability due to the use of the nil-rate band when transferring assets into the trust and the possible loss of additional nil-rate allowances.
How does a trust work in a Will?
A Will writer or solicitor will write the terms and conditions of the trust, as decided by the testator, directly into the Will. This includes naming the assets to be held, the trustees and the beneficiaries. Upon death, the executor of the Will is responsible for ensuring that the assets are transferred to the trustees to manage on behalf of the beneficiaries. The trustee is the person who “owns” the property in the trust or the accounts for cash assets. The trustees are then responsible for the ongoing management of the trusts and distribution of the trusts assets to the beneficiaries. The Trustees ultimately decide how the assets in the trusts are used, however, their decisions must be in the best interests of the beneficiaries.
Types of Will Trusts
What is a life interest trust?
A life interest trust can also be referred to as a property protection trust or an interest in possession trust.
A life interest trust allows a nominated person to have an interest either in the income from an asset or use of an asset for as long as they live or for a specific period, provided certain conditions are met. The person with the life interest is not the owner of the asset, they are only receiving benefit from it. This means that the asset is not part of the life tenants estate and cannot be used to fund their long term care fees or be considered part of their estate and distributed according to the life tenants Will.
For example, the Will can state that the life interest in the property should be given to their spouse, making them a life tenant, but their children should inherit the property if the life tenant chooses to remarry, live with someone else or pass away. Until then the property is held in trust for the beneficiary.
How does a life interest trust work?
A life interest trust is commonly used where a property is involved and is an effective way to ensure a spouse or civil partner is able to continue living in the family home whilst passing it onto other beneficiaries after they pass away.
There are 2 ways of jointly owning property: as beneficial joint tenants or as tenants in common. In both cases, the whole of the property is owned by both spouses or civil partners. The difference between them is subtle but fundamental to the property’s protection.
In the case of beneficial joint owners when one of the partners passes away the property automatically goes to the surviving partner; it is said to pass by survivorship from one to the other. It doesn’t form part of the deceased’s estate and therefore cannot be left in the Will to anyone else. An important point to consider is that if either spouse/partner goes into care all of the property can be used to fund their fees.
In the case of tenants in common the whole property is still owned by both partners but as a 50% share each. If a life interest trust is used, if either partner goes into care only their 50% share of the property is available to a local authority or a private care provider to fund this. The other 50% belongs to the trust and its beneficiaries.
Once the terms of the trust have been fulfilled, for example, the life tenant passes away, it is dissolved, and the assets are passed onto the beneficiaries.
What does it mean to have a life interest in a property?
To have a life interest in a property means that you can receive benefit from the property, either through use or income, for as long as you need or until you pass away.
Depending on the terms of the trust, a person with a life interest may even be able to sell the property to downsize and purchase a more suitable property from the funds raised. And, if the Will states that they have an interest in any income generated by the property, the life tenant can rent the property and receive any rental income generated. However, a life tenant cannot sell their interest in a life estate to someone else.
What is a Discretionary trust?
Unlike a life interest trust, where what happens to the assets is dictated by the trust, a discretionary trust gives the trustees total discretion over what they do with the assets. They can decide which beneficiaries to distribute to, how much they will get and when. Often the deceased will have included in their Will a letter of wishes to give the trustees guidance and insight on how they would like assets to be dealt with.
Discretionary trusts are particularly useful where an automatic distribution to the beneficiaries would be disadvantageous. For example, where beneficiaries are: under the age of 18, disabled, on benefits, unable to manage money, going through a divorce or having financial difficulties etc.
How does a Discretionary trust work?
A discretionary trust can be created whilst the settlor (the person creating the trust) is alive through the creation of a trust document (a trust deed) or created in a Will to come into force upon their death.
When setting up a discretionary trust it’s not necessary to specify exactly who will receive what, when or how. The settlor can define groups of beneficiaries they want to benefit from the trust rather than individuals, for example, children and grandchildren. An individual in a named group is known as “potential” beneficiaries. They are not the owners of the assets and not automatically entitled to the funds whenever they want or at all. It is up to the Trustees discretion to manage the assets and distribute them as they see fit. Trustees have a fiduciary responsibility towards the beneficiaries to act in their best interest. However, they also have an overriding duty to act in accordance with the terms and conditions of the trust.
When assets are transferred into a discretionary trust, they are considered for inheritance tax purposes. Transferring assets into a discretionary trust created in a Will upon the settlor’s death will use their inheritance tax-free allowance (a nil-rate band) of £325,000. If assets are transferred into the trust whilst the settlor is alive they could be considered either a Potentially exempt transfer or a Chargeable Lifetime Transfer and will need to be assessed for inheritance tax.
This doesn’t necessarily mean that any tax becomes payable. It is always advisable to seek advice on the tax implications of a discretionary trust.