How trusts can be used to protect assets

Most people have heard about trusts. In everyday life, the word most often comes up when dealing with life assurance policies, pensions and wills. They are also often used – particularly high net worth individuals – to protect assets. But do you really know what a trust is and why it is something you should think about? In this article our experts take a closer look.

What is a trust?

There is no legal definition of ‘trust’. A trust is not a legal person but, rather, a relationship. The people involved with the trust are known as the following:

• settlor
• trustees
• beneficiaries

The settlor provides the property for the trust (known as ‘settling’ property into trust). The trustees then hold the settled property in their name on behalf of the beneficiaries. Finally, the beneficiaries are those who benefit from the trust and therefore have a ‘beneficial’ right to the trust assets.

The type of beneficial right someone has in a trust depends very much on the type of trust and how the trust deed (the document which sets out the rules of the trust) is drafted.

What are the different types of trust?

There are a numerous types of trust raging from bare trusts all the way through to complex offshore trusts. However, for most clients, the main two types of trust to consider are ‘life interest trusts’ and ‘discretionary trusts’.

Life Interest Trusts

This type of trust entitles one or more beneficiaries to the right to the income from the trust but not the capital.  Life interest trusts are often used in wills to provide an income for a surviving spouse or partner without risking the loss of the capital sum from anything such as subsequent marriage, care fees or creditors. Because the surviving spouse or partner only has a right to the income, this is the only part which can be assessed for any claim against the surviving spouse or partner’s assets. They are not entitled to the capital and thus the capital can be protected from threats such as these.

As well as being established within wills, life interest trusts may also be created during someone’s lifetime. This may be to achieve other aims such as avoiding the need for probate on death or, for example, to protect against any future claims against the estate by family members.

Discretionary Trusts

A discretionary trust, as the name suggests, provides discretion to the trustees to use the trust fund to benefit one or more of the beneficiaries as and when appropriate. In most cases, the ‘class’ of beneficiaries will be family members and thus the trust fund can be used to provide for loans or capital payments to beneficiaries at the right time as they need it for either study, lifestyle needs or business purposes.

With a discretionary trust, no individual has an absolute right to the capital in the trust fund and thus discretionary trusts can be very useful for wealth protection.

To ensure the wishes of the client are followed the trustees are normally provided with an ‘expression of wishes’ form or a ‘letter of wishes’ drafted by or on the instruction of the client. These are essentially the same thing and, whilst not binding on the trustees, should make it clear under what circumstances and in what proportions the beneficiaries should benefit. The client may make contingencies in the letter of wishes to account for situations in the future such as the divorce or bankruptcy of their beneficiaries for example. This ultimately is designed to protect beneficiaries from losing all or part of their inheritance and preserving the family wealth for successive generations.

In certain situations, discretionary trusts can also be used to reduce an individual’s inheritance tax liability although this area of law is complex and is outside the scope of this overview.

To find out more about trusts and how you can use a trust to protect your assets, please get in touch with our private client specialist Steven Smith on: