Trust funds: everything you need to know
Most people have heard of trust funds, but with numerous different types of trusts available, they can be complex to understand and are often mistaken for a financial product that only the wealthy can consider. On this page, you’ll learn how trust funds work, the different types and why you may want to consider setting up a trust fund.
- A trust fund allows you to assign a trustee to manage your assets on your behalf and pass them on to your beneficiaries
- You can specify how your funds are handled in your trust deed, and apply additional rules regarding beneficiaries and how they will acquire some or all of your assets
- Trusts can be taxed, depending on the type of trust fund you choose
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What is a trust fund?
In simple terms, a trust fund is an agreement where a person or group of people have control over assets or cash on someone else’s behalf. For example, your grandfather could give money or assets intended for you to your father, who then passes it on to you with instructions on how he wants you to spend it. In a trust, this agreement is legally binding to ensure you comply with your grandfather’s original wishes.
To expand, a trust fund is a way of managing your assets by placing them in the care of trustees, with the aim of giving them to a specified beneficiary. A trust is often used to minimise the tax implications on your assets, and allow your beneficiaries to access your assets when you pass away. In every trust fund, there are three ‘main players’, who are the following:
- The settlor (also called the grantor, trustor, creator, or trustmaker): this is the person who establishes the trust fund and donates their property, money, business, or anything else of value. The settler is responsible for deciding how to distribute the assets, and they stipulate the trust fund’s management terms.
- The beneficiary: the person who benefits from the trust fund or for whom the fund was initially established. The beneficiary is granted access to the assets in the trust, but not outright ownership of them. The asset or assets within the trust are managed by the trustee(s) for the benefit of the beneficiary.
- The trustee: a trustee can be a single individual, an institution or multiple trusted advisors, depending on the settlor’s preferences. A settlor could also act as a trustee, and this is common within trusts set up by parents for their children. Trustees are responsible for making sure the trust fund follows the duties set out in legally binding trust documents, usually called the trust deed.
In the UK, if your child was born between 1st September 2002 and 2nd January 2011, they may have a savings pot set aside for them in the form of a child trust fund. Find out more about child trust funds, how they work and what you can do if your child has a child trust fund.Read more
How do trust funds work?
A trust fund allows you to set rules on how and when your assets will be passed on to beneficiaries you select. For example, you may want to leave money to your grandchildren, but don’t want them to spend it on things you might think unnecessary. As the settlor, you can dictate the rules of your trust, and require your grandchildren to be of age before benefitting from your assets. You could also designate your funds to a specific purpose, such as education fees. These rules are ultimately dependent on the type of fund you choose.
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What’s the best type of trust fund?
The best type of trust fund is the one that’s right for you and your financial situation. The following are the main types of trust funds in the UK:
- Bare trusts – Assets you place in a bare trust will be held by under the name of your trustee, but the beneficiary you choose will have the right to all the assets in the fund at any time once they reach the age of 18. This means assets that you set aside as the settlor will go directly to your beneficiary.
- Interest in possession trusts – Aside from any incurred expenses, the trustees of an interest in possession trust must transfer all income to the beneficiary.
- Discretionary trusts – In this type of trust, the settlor allows their trustees to make decisions about how they use trust income and capital. Depending on what the settlor states in the trust deed, trustees can decide what gets paid out, who it gets paid to, how often payments can be made, and any other requirements that must be met.
- Accumulation trusts – A settlor can allow trustees to accumulate income within the trust and add it to the capital. Trustees may be able to pay income, as in the case of discretionary trusts.
- Mixed trusts – This is the combination of one or more types of trust, where each type of trust is treated according to that trust’s tax rules. Mixed trusts are a good choice for those wishing to apply the rules of various trust types.
- Settlor-interested trusts – In this type of trust, the settlor or their spouse is the beneficiary. This type of trust is usually set up to be used in times of need, as the settlor or their spouse or civil partner may use it for medical bills or periods of unemployment.
- Non-resident trusts – This kind of trust is specifically used for trustees who aren’t based in the UK for tax purposes. The tax rules for this type of trust tend to be very complicated.
Why set up a trust fund?
One of the main reasons you might want to consider setting up a trust fund is to avoid high tax implications on your assets or estate. Additionally, some types of trust funds do not have to go through probate – the process of analysing and distributing assets after someone dies without leaving any instructions behind – which can mean court costs can be avoided.
A trust fund could also be used to ensure the continued protection of your assets even after you have passed away, and to ensure that your assets pass on to someone you deem responsible and reliable. As always, your own circumstances are individual and you should enlist the advice of a qualified tax advisor on this matter – the above information does not constitute any form of advice or recommendation.
Pros and cons of trust funds
The main attraction of a trust fund is that you can pass on property and assets to your heirs without going through probate, which is the legal (and sometimes costly) process of dealing with a person’s estate, including paying off their debts and distributing their assets as per their will. A trust also allows you to set legally binding rules which serve as directives on handling your assets once you pass away.
Setting up a trust can also be a good way to protect your assets in the event of a divorce or bankruptcy, as well as managing the assets of someone who is unable to, such as young children.
One disadvantage of trust funds is in the initial set-up of the trust. It generally takes a lot of preparation and can incur considerable legal fees. Once you place assets in a trust fund, it’s then legally binding, meaning that you may not be able to get your assets back if you change your mind.
It can be time-consuming and expensive to set up a trust fund, but it can be a good option to ensure peace of mind, with the knowledge that your assets are well taken care of should you pass away.
Are trust funds taxed?
Taxes will apply based on the trust fund you choose, as each type of trust is taxed differently.
For example, in accumulation or discretionary trusts, trustees are responsible for paying tax on the income received. The first £1,000 is usually taxed at the standard rate of 20%. However, if you have more than one type of trust fund, then the £1,000 will be divided between the number of trust funds you have.
The standard tax rate if you’re within £1,000 is 20%, but once you go over this amount, the tax rate is 45% of your trust’s income.
Am I eligible to set up a trust fund?
It’s a common misconception that trust funds are just for the wealthy; anyone who has assets or possessions they wish to pass on is eligible to set up a trust fund.
How do I set up a trust?
Identifying what type of trust is best for you and your personal circumstances is the logical first step in setting up a trust fund. While different types of trust have different set-up procedures, they commonly include the following:
- Declaring assets
You’ll need to list all the different assets you own, and their value, that you want to include within the trust.
- Appointing trustees
You’ll need to select an individual or individuals who you trust to manage your assets or identify a management company that will bear the legal authority to control your assets.
- Determine beneficiaries
This requires the settlor to create a list of beneficiaries that they want to allow access to the trust fund and receive any benefits. The settlor may also include a percentage on each asset of how much each beneficiary is entitled to receive.
- Outline terms
This focuses on the trust deed composition, which is the legal document that prescribes any rules set up to govern the fund and empower the trustees.
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