Trusts: A Complete Guide to Estate Planning, Asset Protection, and Inheritance Tax

What is a Trust?

A trust is a legal arrangement where one or more people, called trustees, legally own assets on behalf of others, known as beneficiaries. In other words, the trustees are responsible for managing the assets, but the benefits of those assets go to the beneficiaries.

Trusts are commonly used in estate planning to:

• Protect assets from risks such as bankruptcy, divorce, or poor financial management
• Manage wealth and control how it is distributed to family members
• Plan for Inheritance Tax, helping to reduce the tax burden on an estate

There are several types of trusts, depending on the beneficiaries’ rights to the assets and the goals of the settlor (the person creating the trust). Some trusts give beneficiaries income from the assets, others allow access to the capital, and some offer a combination of both.

A trust can be established during the settlor’s lifetime, known as a lifetime trust, or under the terms of a Will, referred to as a Will trust. By carefully choosing the type of trust, the settlor can ensure that assets are protected, distributed according to their wishes, and used efficiently for tax planning purposes.

Inheritance Tax Planning: Lifetime Trusts

If a person’s estate is larger than the available Inheritance Tax allowances, any amount over the limit can be taxed at 40% when they pass away. One way to reduce this tax is to lower the value of the estate before death.

While it is possible to give gifts directly to family or friends, this approach can be risky if the recipients are not financially secure. Instead, placing assets into a lifetime trust can reduce the taxable estate while keeping the assets safe.

Assets in a lifetime trust are protected from risks such as:

• Spendthrift behaviour
• Bankruptcy
• Divorce settlements
• Unwanted claims from third parties

Lifetime trusts can also be planned to support future generations. They can provide funds for education, buying a first home, or raising children, all while keeping the assets secure from potential tax liabilities.

Will Trusts: Protecting Assets After Death

A Will trust is set up as part of a person’s Will and is mainly designed to protect assets, rather than reduce Inheritance Tax. It ensures that property and other assets are used in accordance with the wishes of the person who created the trust.

For example, a Will trust can be used to place a share of a marital property into trust so that a surviving spouse or partner can continue living in the home. When the surviving spouse passes away, the property passes to the children of the trust creator, safeguarding the assets for the intended beneficiaries.

Will trusts also provide protection in other situations. They can prevent assets from being passed to a new spouse or their children if the surviving spouse remarries, and they can help protect the estate when calculating Local Authority care home fees, as assets held in the trust are generally ring-fenced and not used to pay for care.

Types of Trusts: Life Interest, Discretionary, and Flexible

The type of trust a settlor chooses depends on how they want their beneficiaries to receive their entitlement.

A Life Interest Trust gives a named beneficiary, known as the life tenant, the right to receive income generated by the trust assets during their lifetime. After the life tenant passes away, the capital or remaining assets are distributed to other beneficiaries, ensuring that the settlor’s wishes are carried out across multiple generations.

A Discretionary Trust works differently. The settlor identifies a group of potential beneficiaries, known as discretionary objects, but does not specify exactly how the assets will be divided. Instead, the trustees have the flexibility to decide who receives income or capital based on each beneficiary's individual needs. This makes discretionary trusts particularly useful for families where beneficiaries have differing financial circumstances or where flexibility is required to respond to changing situations.

There are also Flexible Trusts, which combine the features of a life interest with discretionary powers. The trustees can manage the income for a life tenant while retaining the power to distribute the capital either to the life tenant or to a wider class of beneficiaries, providing both income security and adaptable distribution.

Why Trusts Are a Powerful Tool in Estate Planning

Trusts are a highly effective way to protect and manage wealth in UK estate planning. They not only help reduce Inheritance Tax liabilities by managing the size of an estate but also safeguard assets from risks such as divorce, bankruptcy, or poor financial management. Beyond protection, trusts offer flexibility, allowing trustees to tailor distributions of income or capital to meet each beneficiary's specific needs.

Perhaps most importantly, trusts enable generational planning, ensuring that family members are supported now and in the future, whether for education, buying a first home, or raising children.

By using a trust, individuals can achieve peace of mind knowing their assets are protected, their wishes are respected, and their loved ones are provided for across generations.

Get in touch

If you would like to learn more about how a trust could benefit you and your family, or if you are considering setting up a lifetime or Will trust, our specialist Trusts team is here to provide guidance. You can speak to an expert by calling 01329 288121 or by emailing enquiries@warnergoodman.co.uk to discuss your options and find the right solution for your circumstances.