Trusts Explained
Download Trusts
Explained as a PDF leaflet (770 kb)
|
Many people, often without realising it,
will come into contact at some point of their lives with a trust in
one form or another. Yet trusts are widely misunderstood and often
seen as something just the rich need be concerned with. This
leaflet aims to give a quick overview of how trusts work, what they
are most commonly used for and to correct some of the widespread
misconceptions held about trusts. Trusts are found around the
world, but particularly in those countries where the legal system
has its roots in the English system. The exact technical details of
trusts, how they are set up and how they are taxed vary from
country to country, so this guide focuses only on some of the broad
principles. If you need to know more you should contact a
professional advisor
|
What is a trust?
Trusts are, in principle, a very simple concept. A
trust is a private legal arrangement where the ownership of
someone’s assets (which might include property, shares or cash) is
transferred to someone else (usually, in practice, not just one
person, but a small group of people or a trust company) to look
after and use to benefit a third person (or group of people
|
The person giving the assets is usually known as the
“settlor” in the UK or a “grantor” in the US (but can also
sometimes be called the “trustor” or the “creator”). The people
asked to look after the assets are called the “trustees” and the
person who benefits from the trust is called the “beneficiary”. The
details of the arrangement are usually laid out in a “trust deed”
and the assets placed in the trust are the “trust fund”.
One common misconception is that the assets in the
trust fund are legally owned by the trust. In fact, a trust, unlike
a company, cannot own assets and instead the trustees are the legal
owners of the assets. The distinctive feature of a trust is
therefore the separation of legal ownership and beneficial
ownership of the assets in the trust fund. The trustees are the
legal owners of the assets, but the trustees must at all times put
the interest of the beneficiaries above their own. Thus, the
settlor of trust can be a trustee, but they must still act in the
interests of the beneficiary, not themselves.
Trusts can take effect during the lifetime of the settlor (in
which case in the UK they are called a “lifetime settlement”) or
shortly after the death of the settlor (in which case in the UK
they are called a “will trust”). There is also a wide-range of
different types of trust depending, for example, on how the
benefits of the trust fund are to be distributed. The basic
principle that a trust contains assets owned by someone for the
benefit of someone else nevertheless remains true in all forms of
trust.
Why use a trust?
Trusts are very common indeed and play a key role in many
aspects of everyday life. In the UK, for example, most company
pension schemes are structured as trusts, with the employer (who in
this case is the settlor) giving cash to a pension fund manager
(the trustee) to invest for the benefit of employees when they
retire (the beneficiaries). The trust structure helps clarify the
administration, regulation and taxation of the pension fund.
Similarly, many life insurance policies are “written in trust”
so that when the person insured dies the policy pays out to a trust
run by the insurer, which then pays the cash out in line with the
insured person’s wishes. The trust structure both helps minimise
inheritance taxes (see more on this in the section on trusts and
taxes) and ensures that the deceased’s wishes about how the
insurance funds are to be distributed can be followed quickly and
accurately.
Trusts are also very commonly used for charitable funding (in
the US, foundations are also often used for similar purposes). In
the UK, for example, the Wellcome Trust donates well over £300
million annually to medical research, but as well as the large,
well-known charitable trusts, there are a wide range of smaller
trusts created to help fund a particular good cause. One of the
great advantages of the trust structure for charitable funding is
that the person setting up the trust can simply indicate how they
wish the funds to be used (for example, “for medical research”),
but leave it to the trustees to decide over time which medical
research projects should be funded. This highlights the benefit of
the flexibility inherent in trust structures when someone is making
long-term commitments.
|
|
For most people, however, the type of trust they are most likely
to be asked to make decisions about personally is a trust
established to arrange their family’s financial affairs. In this
context, the main attraction of trusts is that they give the
settlor greater confidence in how assets will be used in the
future. Put simply, trusts offer a means of holding and managing
money or property for people who may not be ready or able to manage
it for themselves. Indeed, trusts can be created to benefit people
who are not even born yet – such as any future grandchildren
someone may have Some of the most common family situations
where trusts are used (often in conjunction with a will)
are:
- to provide for a husband or wife after death
while protecting the interests of any children
- to protect the inheritance of young children
until they are old enough to take responsibility for their own
efforts
- to provide for a vulnerable relatives who are
unlikely to be able to look after their own affairs and
- to help succession planning in family
business
|
It is clear that trusts are particularly useful when planning
how money and assets should pass from one generation to another,
especially when family structures are complicated by divorces and
second marriages. This, coupled with the growing frequency of
marriage breakdowns, may explain the huge increase in popularity of
trusts in many countries. In the US, for example, the number of
domestic trusts filing for tax each year has doubled since the mid
1970s. In 2003, 3.6 million US domestic trusts were filed for tax
purposes and they are now the third most common form of filing in
the US tax system. By 2015, the US Internal Revenue Service
estimates that $4.8 trillion in wealth will be inherited or
transferred from one generation, with much of it transferred
through trusts
Are trusts secret?
Trusts are personal arrangements, often laying out how a
family’s savings are to be distributed within the family. Most
people setting up such arrangements would expect them to be kept
confidential. Quite often, even the beneficiaries of a trust will
not know about the trust, possibly because a parent would prefer
their children not to know that they are likely at some point to
receive benefits from the trust. Another common issue is that there
may be beneficiaries who, in practice, will only receive any funds
from a trust in the most extreme circumstances – such as when all
closer relatives have predeceased them.
Trusts, like bank accounts and most other family financial
affairs, are therefore generally regarded as confidential. Most
people would find it intrusive if they had to publicly
register their credit card accounts and report whether they were in
joint names with their husband or wife. Recognising this, in most
countries where trusts are common there is no requirement to
register a trust. Nor is there any requirement to publish details
such as who the settlor, trustees or beneficiaries are or how much
the fund is worth. Even so, in most of the major economies trustees
do have to inform the tax authorities when a trust is set
up.
Most countries also have strictly enforced regulations requiring
the trustees to establish the identities of the settlor and
beneficiaries and to provide this information to the authorities if
the authorities believe the trust is being used for illegal
purposes. Trustees also generally have a duty to report suspicious
activity to the authorities. Thus, while trusts are confidential,
it would be wrong to regard them as “secret”. Generally, trusts are
no more or less “secret” than bank accounts.
The legitimacy of someone wishing to keep their family financial
affairs confidential is recognised by most governments in the
developed world. Respecting personal confidentiality is generally
regarded as an essential part of good tax governance. The
Organisation for Economic Cooperation and Development (OECD), for
example, has stated that “the obligation to keep taxpayer
information confidential and only release it in accordance with the
law is a fundamental principle” (Engaging with High Net Worth
Individuals on Tax Compliance, OECD, May 2009, pg 53)
Trusts and tax
Trusts are occasionally represented by some
commentators as just devices to avoid tax. In reality, there are
virtually no circumstances in which anyone would be well advised to
set up a trust just to gain tax advantages. In setting up a trust,
the settlor is giving up ownership of the assets in the trust. Such
a dramatic move will normally only make sense if the settlor has
clear objectives that they wish to achieve with those assets, and
tax is likely to be a secondary issue.
In most countries, any tax advantages given to trusts are, in
any case, tightly targeted by the tax authorities at trusts that
are seen as doing a social good. Charitable trusts are an obvious
example, but trusts set up to look after vulnerable or disabled
relatives also often attract some tax advantages. Another example
is the favourable treatment the Canadian authorities give to
immigrant trusts. It goes without saying that there are quite
strict rules about the sorts of trusts that attract significant tax
advantages and the tax authorities tend to police those rules
closely
Most other trusts attract relatively few tax advantages. In the
UK, for example, the official position is to pursue a policy of
being tax neutral towards most trusts, so that the tax system
neither encourages nor discourages anyone from setting up a trust
(although, in practice, most professional advisors think the UK tax
system now actively penalises some types of trust). In line with
this policy of fiscal neutrality, the trustees must give the
UK tax authorities full details when a trust is established and are
generally personally liable for taxes due on the trust. Similarly,
in the US, the declared intent of the Internal Revenue Service is
that there should be no income tax advantage to trusts and there
are onerous trust reporting requirements.
International trends in trusts
It is clear that tax will rarely be the main reason for
setting up a trust. The key attractions are, instead, the ability
of trusts to ensure that assets will ultimately be used in a
certain way while allowing flexibility in how those assets are
managed before they are distributed. That flexibility is
particularly useful in an international context. For example, the
International Monetary Fund (IMF) has established a trust to
channel donor funding to finance technical assistance in its
Anti-Money Laundering and Combating the Financing of Terrorism
programmes. Indeed, this trust fund is expected to be the first of
a series of Topical Trust Funds established to channel multi-donor
funding to key IMF programmes
Families are similarly attracted by the flexibility of trust
structures to cope with a wide range of family circumstances, and
this flexibility becomes particularly important when a family, or
its business interests, are scattered across a range of different
countries, each with its own inheritance, tax and business laws.
Thus, one of the key developments that many professional advisors
have noted has been the growth in demand for advice by
geographically widely based families over the past few years, with
the fall of the Iron Curtain and the spectacular rise in economies
such as India and China being major factors here
Advisors to geographically diverse families will normally
recommend a trust structure based in one of the major international
financial centres. These centres typically offer a strong legal and
regulatory framework, an efficient banking system, a wide pool of
professional expertise in relevant areas and a tax-neutral
environment for trusts and international investors. London and New
York have long played preeminent roles in this context and they
still have dominant positions as international financial centres.
In recent years, however, there has also been rapid growth in
many other international financial centres, including relatively
new centres such as some of the Caribbean jurisdictions, as well as
long-established banking centres such as Switzerland
The rapid growth in these centres has led to significant
pressure from bodies such as the OECD and G20 to regularise their
position in the international tax system relative to the major
economies. This has further highlighted the role of professional
advisors in international centres helping ensure their clients are
tax compliant in a range of different jurisdictions.
The future
Few areas of activity have emerged unscathed from
the recent worldwide turmoil in the banking system and the
consequent weakness in financial markets. Consumer confidence
around the world has been battered and the valuation of family
assets has been under pressure. All these factors might well be
expected to deter people from setting up trusts. In reality, the
indications are that trusts are still widely seen as a useful way
to plan for the long-term future. Generally, the evidence suggests
that trusts continue to grow in popularity.
In many developed countries, major pressures on public spending
are translating into doubts about social welfare programmes. In
these circumstances, the role trusts can play in helping underpin
the future of vulnerable family members is gaining fresh
importance. Similarly, the extreme economic turbulence of the
recent past has demonstrated to many the merits of
diversifying how assets are held internationally and the role
trusts can play here is widely recognised.
The major threats to trust growth instead come from
changes in the tax system. While most of the major jurisdictions
where trusts are common have a stated policy of being tax-neutral
with respect to trusts, in some countries, most notably the UK, the
tax system has, in practice, begun to tilt against trusts – often
it seems unintentionally. While tax advantage is seldom the prime
motivator behind someone setting up a trust, tax penalties on
setting up a trust can be a powerful deterrent and the formation of
some types of family trust has declined rapidly in the
UK.
Most of the developed world is nevertheless adapting to the
needs of ageing populations. Families are frequently concerned
about ensuring that the interests of an ageing parent or
grandparent are protected during a period of their lives when the
ability to make important decisions may become clouded. A
generation that has often managed to accumulate significant assets
over its lifetime is also naturally concerned about how those
assets will be passed on to future generations. These are all
precisely the sorts of issues trusts were developed to address.
Professional advisors remain confident that trusts will continue to
provide popular, practical solutions to problems in ordinary
people’s lives
