How does a family trust protect your assets?

How does a family trust protect your assets?
  • Financial planning
  • 4 minute read

Family trusts can play an important role in estate planning. Not only can family trusts help you protect your assets, but they can also help you pass on your wealth to family members more efficiently. In this article, we look at how family trusts work and explain how to set one up. 

What is a trust?

Before discussing how family trusts work, it’s worth looking at the basics of trusts.

A trust is a legal arrangement in which you transfer the ownership of assets to a third party to hold on behalf of the trust’s members. The party that is appointed to look after your assets is known as the ‘trustee’. It’s the trustee’s role to manage the trust responsibility, in line with your wishes. Those who receive disbursements from the trust are known as the ‘beneficiaries.’

Once assigned to a trust, your assets are no longer deemed to be personal possessions. This means that they are safeguarded from creditors and legal challenges. It also means that they may be subject to different Inheritance Tax (IHT) rules.

You can set up a trust while you’re still alive or write one into your will, to take effect upon your death.

How does a family trust work?

A family trust is a trust that is set up for the benefit of family members.

Common reasons for setting up a family trust include:

  • Setting funds aside for future generations.
  • Passing assets on to a child or grandchild, but not until they are older.
  • Protecting assets when entering into a marriage.
  • Ensuring that a spouse can benefit from family assets for the rest of their life before assets are passed on to children.
  • Passing assets on to family members tax-efficiently.
  • Protecting assets against claims from creditors when self-employed.

In the UK, there are a number of different ways you can set up a family trust. The main types of trusts used for family trusts are:

  • Bare trusts: these are simple trusts in which all trust assets are given to the beneficiary as long as they are aged 18 or over (in England and Wales), or 16 and above (in Scotland). With this type of trust, the trustee simply manages the trust’s assets until the beneficiary is old enough to receive them. Bare trusts are often used to hold assets for children.
  • Interest in possession trusts: with this type of trust, the beneficiary can receive income from the trust’s assets straight away, however, they don’t have the right to the assets until you die. This type of trust is often used in wills in order to give a spouse an income for life. Once the spouse is no longer around, the trust’s assets are passed on to the children.
  • Discretionary trusts: these are more flexible trusts in which the trustee has discretion over the distributions of the trust. Discretion must be exercised in accordance with the terms of the trust deed, however, it is up to the trustee to determine the timing, size, and nature of the distributions. This form of trust can be effective if you are uncertain about the needs of your beneficiaries.
  • Mixed trusts: this form of trust combines elements of different types of trusts.

How do you set up a family trust?

To set up a family trust, you’ll need the help of a solicitor. The rules around trusts are complex and the legal wording of a trust must be precise. You can reduce the professional advice time needed, however, by being well prepared before you start the consultation process.

The four basic steps involved in setting up a family trust include:

  • Deciding upon the trust’s assets: you need to list the assets and value of the assets that you plan to allocate to the trust at inception.
  • Appointing a trustee: you need to select an individual or management company that you can trust to safeguard your assets.
  • Determining the beneficiaries: you need to compile a list of family members that will be entitled to receive benefits from the trust. You also need to include the percentage of total benefits that each beneficiary is entitled to.
  • Outlining the terms in a trust deed: a trust deed is a legal document that lists the rules that govern the trust and the powers of the trustee. It specifies the trust’s objectives, assets, and beneficiaries, and details how benefits should be paid in the future.

Can a family trust reduce your IHT bill?

Family trusts can potentially help you reduce Inheritance Tax (IHT) liabilities. However, the rules around trusts and IHT are complex. The IHT treatment of family trusts depends on the type of trust set up and the amounts transferred into the trust.

For example, assets placed in a bare trust are treated as ‘potentially exempt transfers.’ This means that they can be exempt from IHT, as long as you survive for seven years after transferring the assets into the trust. If you die within seven years of the transfer being made, IHT on the transfer must be paid upon your death.

Meanwhile, discretionary trusts face a 20% IHT charge on assets not covered by your nil rate bandwhen the trust is set up, followed by a 6% IHT charge each 10-year anniversary. In addition, IHT of up to 6% will need to be paid when the trust is closed or assets are removed.

If you plan to set up a trust for Inheritance Tax planning, it’s a good idea to seek advice from a financial adviser first. 

What are the alternatives to family trusts?

One alternative to a family trust is a Family Investment Company (FIC). This is essentially a private limited company designed to manage the wealth of a family in a flexible way. A FIC can be a good way of transferring assets to the next generation in a controlled manner.

With a Family Investment Company, different share classes can be allocated to different family members, enabling these family members to have different levels of control over company decisions, as well as different rights to receive dividends and entitlements to the capital value of the company. Parents can potentially transfer assets to their children in stages through the company structure, while retaining control of the company.

FICs are treated differently to trusts for tax purposes, meaning that they can potentially be a more tax-efficient way of passing on wealth, depending on your circumstances

Family trusts: an efficient way to pass on wealth

Given their practicality and ‘safe-haven’ attributes, family trusts can be an excellent way to preserve family wealth and pass on assets to future generations smoothly.

However, the rules around trusts are complex in nature. Therefore, it’s imperative to engage an experienced solicitor when setting up a family trust. A solicitor will help you understand what’s involved in setting up a trust and will also help tailor your family trust to your own personal needs.

To find out more, or if you have any questions about setting up a family trust, don’t hesitate to contact us by clicking the button below.

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Capital at risk. Any tax benefits will depend on your personal tax position and rules are subject to change.

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