How trusts can be used to protect assets

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. The beneficiaries 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 number of different types of trust, most of which are outside the scope of this article. 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 (common risks to capital include care fees, creditors and subsequent marriages). As the surviving spouse or partner only has a right to the income, the capital is not regarded as their asset for most purposes and thus it can be protected from threats such as those mentioned above.

As well as being established within Wills, life interest trusts may also be created during a client’s lifetime (often referred to as a ‘Lifetime Trust’). 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 with whom there are ongoing disputes.

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 interest-free loans or capital payments to beneficiaries at the right time as they require capital; whether that is for education, 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. The use of trusts in this way is designed to protect beneficiaries from losing all or part of their inheritance and preserve 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 article.

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