Trusts Explained: A Plain-English Guide to How Trusts Work in England and Wales

Trusts Explained: A Plain-English Guide to How Trusts Work in England and Wales

What Is a Trust?

At its simplest, a trust is a legal arrangement where one person (the "settlor") transfers assets to another person or persons (the "trustees") to hold and manage for the benefit of specified people (the "beneficiaries").

The key concept is the separation of legal ownership from beneficial enjoyment. The trustees legally own the assets, but they do not own them for their own benefit — they hold them on behalf of the beneficiaries, and must manage them in accordance with the terms of the trust and the law.

The People Involved

The settlor. The person who creates the trust and transfers assets into it. In the case of a trust created by a will, the settlor is the person who has died.

The trustees. The people responsible for managing the trust assets. Trustees have a legal duty to act in the best interests of the beneficiaries, to act impartially, and to comply with the terms of the trust. Trustees can be family members, friends, or professionals such as solicitors or accountants.

The beneficiaries. The people who benefit from the trust. Depending on the type of trust, beneficiaries may have a fixed right to income or capital, or they may be part of a wider class of people who the trustees can choose to benefit at their discretion.

Common Types of Trust

Bare trusts (or simple trusts). The trustees hold assets for a named beneficiary who has an absolute right to both the capital and the income. Once the beneficiary is 18, they can demand the assets be transferred to them. Bare trusts are often used for holding assets for children.

Life interest trusts (interest in possession trusts). A named beneficiary (the "life tenant") has the right to income from the trust assets, or the right to use a trust asset (such as living in a property), during their lifetime. When the life tenant dies, the capital passes to other named beneficiaries. Life interest trusts are commonly used by couples to protect assets for children from a previous relationship.

Discretionary trusts. The trustees have absolute discretion over how to distribute income and capital among a defined class of beneficiaries. No individual beneficiary has a right to anything — the trustees decide who benefits, when, and how much. This flexibility makes discretionary trusts particularly useful for protecting assets from divorce, bankruptcy, or financial imprudence.

Disabled person's trusts. Trusts established for the benefit of someone who is disabled, with favourable tax treatment.

Accumulation and maintenance trusts. Trusts designed to build up assets for beneficiaries (often children) over time.

Trusts Created During Lifetime vs Trusts in a Will

Lifetime trusts are set up during the settlor's lifetime by executing a trust deed and transferring assets into the trust. These have immediate effect and can have immediate tax implications.

Will trusts are created by the terms of a will and only come into effect on the testator's death. Common examples include life interest trusts for a surviving spouse and discretionary trusts for children.

Why Use a Trust?

Trusts serve many legitimate purposes: protecting assets for future generations, providing for vulnerable beneficiaries, inheritance tax planning, preventing sideways inheritance, and — with important caveats — protecting against care home fee assessments.

On the last point, local authorities have the power to treat a transfer into a trust as a "deliberate deprivation of assets" if the primary purpose was to reduce the value of your estate for means-testing. Any trust must be established for genuine estate planning reasons.

The Tax Position of Trusts

Trusts are subject to their own tax regime. Transfers into most trusts are "chargeable lifetime transfers" — if the total exceeds the nil-rate band (£325,000), there may be an immediate IHT charge of 20%. Trusts are also subject to a periodic charge (up to 6%) every ten years and exit charges when capital is distributed. Income tax and capital gains tax also apply at special trust rates.

Registration Requirements

Since 2022, most trusts must be registered with HMRC's Trust Registration Service (TRS). Failure to register can result in penalties.

A Word of Caution

Trusts are powerful tools, but they are not a magic solution. Poorly structured trusts can create more problems than they solve. Some trusts have been the subject of mis-selling, particularly so-called "asset protection trusts" marketed as a way to avoid care home fees or inheritance tax.

Any trust should be established with clear objectives and professional advice from a suitably qualified solicitor.

If you are considering a trust, please contact Safe Harbour Legal. As a STEP-qualified solicitor, Aaron Johnson can advise on the full range of options.

This guide is intended as general legal information and does not constitute legal advice. Safe Harbour Legal is a trading name of Legal Studio, authorised and regulated by the Solicitors Regulation Authority.