A Trust is a legal entity, which enables one person

to hold property on behalf of other people, and that

person has to deal with the property so as to benefit

the other people.  A simple example of a Trust which

I come across which has no legal documents but is

a trust nevertheless is where an elderly person sets

up a joint account with a relative and arranges for her

pension to be paid into that bank account and thenthe

relative pays any bills that fall due for the elderly person.

                                                                                                        

How do you set up a Trust? 

The informal trust described above will normally work perfectly satisfactorily but, even with a situation as simple as that described, it would be helpful to have something in writing so each person knows just what can and cannot be done.  Where a trust is being created dealing with a house or land or other substantial assets then the Trust must be in writing, not least because the Inland Revenue will want to know what is happening and also because, as the law of Trusts has developed in this country it has become possible to build into the Trust a lot of flexibility.  You will see from the definition of a trust stated above that the Trust contains an element of one person holding on behalf of another and so the first question to consider is who will hold the property.  These people are called Trustees.

 

Who can be Trustees?

Any adult person who is of sound mind can be a Trustee and in addition you can appoint a bank, a firm of solicitors or accountants to be Trustees on your behalf.  In practice I would suggest that you appoint yourselves as Trustees with no more than two other members of your immediate family.  The Law states that no more than four people can act, as Trustees and I would normally suggest having at least two Trustees.

 

What do Trustees do?

Broadly speaking, they do whatever they are directed to do in the Deed of Trust Settlement.  This document sets out the ground rules by which the Trustees will operate and will give them the power to do certain things like sell a house and purchase another house or transfer money from one investment to another investment and will also limit what they can do, for example prevent the Trustees from putting money into high risk investments.

 

What property can be put into a Trust?

Any property owned by you can be put into the Trust whether it is land, a house or other investments like shares, building society accounts or life insurance policies.  However, a word of caution is needed at this stage because you must remember that even though you may retain some control over property in a Trust the fact remains that you no longer own that property, the Trust owns the property.  Therefore it may not be advisable or desirable to retain any right to ask for part or all of the property to be returned during your lifetime although in the normal course of events you would receive the income from the property or investments during your lifetime.

 

Can I change the Trust in the future?

Yes, you can.  You can change the Trust in the future by putting more investments or assets into the Trust or you can change what is to happen in the event of your death and whom the Trust money is to go to ultimately when the Trust ends.  This gives some of the flexibility that you have when making a Will.

 

Do I need to change my Will?

You should certainly consider your Will because any property transferred into a Trust will not become part of your estate on death and so your Will does not govern who receives that money, that will be governed by the Trust Settlement.  You should therefore look at your Will and consider whether or not it will need to be amended.

 

Case History about using a Trust

Mr and Mrs X live in a property worth £150,000.00.  Mr and Mrs X also have savings of £60,000.00.  They look after a disabled daughter Y, who lives with them.  They receive attendance allowance for looking after their daughter, who has no income of her own.  Mr and Mrs X have two other adult children, W and Z, who both work and have families of their own.  Mr and Mrs X are concerned to provide for their daughter in the event of their death but they realise that if they leave the house to daughter Y then this will only serve to prevent her from receiving state benefits until all the money has been used following a sale of the house and she is unlikely to derive any direct benefit.  Mr and Mrs X are also worried about what would become of their daughter if they themselves needed residential care in the future.

Mr and Mrs X decide to transfer the house into Trust and appoint themselves and their adult child Z as Trustees.  They decide that the Trust will last not only for their lifetime but also for the lifetime of their disabled daughter Y and say that at the time of her death the Trust would finish and the proceeds from the Trust would then be divided equally between their children W and Z or their grandchildren if either of their children W and Z have died before.

They make it clear in the Trust that the house could be sold in the future and a more suitable property purchased, either for themselves or their disabled daughter and if there is any money left over following the sale of the house and the purchase of another house then it will be invested so as to provide an income for themselves or their disabled daughter during their lifetimes.

They then change their Wills and leave all the rest of their property to their children W and Z or grandchildren in equal shares.

 

What does this achieve?

• In the event of either Mr or Mrs X dying and the survivor needing residential care in the future, the house is protected for the benefit of their daughter.
  

• As their daughter Y does not own the house she will not become disqualified from receiving income support or other state benefits when her parents die or are unable to look after her in the future.  The house belongs to the Trust.
  

• By having the property in trust until daughter Y dies there is no temptation upon the children W and Z to move their disabled sister on to residential care so as to realise the house for their own benefit.  The house or its proceeds of sale will remain in the Trust for the benefit of daughter Y during her lifetime and the children W and Z have to content themselves with the sure and certain knowledge that either they themselves or their children will ultimately benefit from the Trust.

 

Why not just give the house to the children W and Z?

At first sight this is a simple and attractive proposition but how do the parents ensure that the children W and Z will use the property for the benefit of their disabled sister?  A document can be prepared setting out some basic ground rules and saying that the children should not sell the house during the lifetime of their sister but the fact remains that the house belongs to the children W and Z.  Difficulties can arise if the children W and Z have their own serious financial difficulties, which at least might lead them to “bend the rules” and at worst ignore the agreement entirely.  It should also be remembered that the children W and Z actually own the property and so if they run up debts for themselves then any creditor can look towards their interest in the property for payment of the debt.  Ultimately, this could lead to the property being sold to pay the debts of W or Z and this does not adequately protect their sister Y.

It should also be remembered that the share of the house owned by the children W and Z would be taken into account, if their own marriage failed, as part of the marriage settlement, even although they may have no present enjoyment of the property because their sister Y continues to live there.  This is hardly fair or desirable for the children W and Z.

 

What is the tax position?

 

Inheritance Tax

At current rates Inheritance Tax is charged at 40% on all assets you own at the time of your death over and above the tax-free limit of £325,000.00.  Therefore if your combined wealth is less than £650,000.00 then Inheritance Tax should not be an issue.  If your combined wealth exceeds £650,000.00 the Inland Revenue say that if you transfer the ownership of an asset into trust this will not prevent the value of that asset being brought into account on your death if you reserve a benefit for yourself during your lifetime.  Thus, for example, if in the Case History Mr and Mrs X had a further £200,000.00 worth of savings in addition to their house there would be no saving in Inheritance Tax by transferring the house into trust as they continue to live in the house during their lifetime and therefore reserve the benefit of occupation for themselves.

 

Capital Gains Tax

This is a tax on the difference between the price you pay for an asset and what you eventually sell it for and is currently charged at 40% of the gain.  Many people do not come across this tax during their lifetime because your family home is exempt from Capital Gains Tax.  This is because there is no Capital Gains Tax to pay on the sale of a house, which you own and occupy yourself, this is called the main residence exemption.  However, if you own a second property, which you do not live in, then you will pay Capital Gains Tax.

If your home is transferred into the Trust then it ceases to be owned by you and is owned by the Trust instead.  You would have thought in those circumstances that Capital Gains Tax would be payable, but the Inland Revenue will allow the Trust to claim the main residence exemption where the house is being occupied under the Trust by somebody who also benefits from the Trust.  As a result and as long as you continue to occupy your house then there will be no Capital Gains Tax to pay when it is eventually sold. 

 

You should note that if you cease to occupy the house and the Trustees decided to rent it out to tenants then Capital Gains Tax would become payable on an eventual sale of the house on the difference between its value when it was first rented out and the eventual sale price.

In the example of Mr and Mrs X, if they had both died or were in residential care then so long as the house was occupied by their daughter the main residence exemption would still apply because their daughter can benefit under the Trust set up by her parents.