Lorraine Wilson explores five common misconceptions about trusts.

Trusts can be a useful tool in estate planning, enabling an individual to provide for their chosen beneficiaries by alternative means rather than an outright gift. There are many types of trusts which serve distinct purposes and have different financial and tax consequences. However, it is often misunderstood what the benefits of trusts are and how they work.

Trusts are only for the wealthy

Trusts can be useful for a variety of reasons. Trusts are most commonly used as part of an individual's estate planning to suit the needs and circumstances of beneficiaries rather than the high value of their estate. For example, trusts can be a sensible means of providing for disabled or vulnerable beneficiaries who may be unable to manage their own affairs, or where there are concerns about a beneficiary's spending habits, so an additional layer of protection is desired.

There is no minimum amount that can be held in a trust, though the ongoing administrative costs should be borne in mind for smaller trusts if these are likely to be disproportionate.

Trusts are a way of avoiding tax

Trusts are subject to their own tax regimes. In fact, the tax rules applicable to trusts are often more punitive than those applying to individuals or companies with trusts paying the highest rates of income tax, stamp duty and capital gains tax and having minimal allowances. Nevertheless, many consider the tax charges a price worth paying for the protection offered to beneficiaries by a trust structure.

Some trusts will be subject to Inheritance Tax on the death of a lifetime beneficiary, whereas others will be charged Inheritance Tax on a regular basis during the life of the trust (every ten years and/or whenever monies are paid out of the trust to a beneficiary. Some trusts attract special tax status if the beneficiary meets certain criteria for being classed as 'vulnerable'.

Many people incorrectly believe that leaving their estate on trust after they die will mean they do not have to pay any Inheritance Tax. Inheritance Tax is charged on the value of a person's estate on the date of their death. Generally speaking, UK Inheritance Tax is assessed on the value of assets belonging to the deceased, regardless of whether the beneficiary is an individual or a trust (unless the estate is left to a surviving spouse or civil partner or to a charity, in which case special exemptions may apply).

It is important for those wishing to set up a trust to seek advice on the tax consequences, as well as trustees, in order to keep their tax obligations under constant review.

Trusts can only be created in lifetime

Whilst it is true that an individual can create a trust during their lifetime and there may be good reason for doing so, it is also possible to create trusts which only come into existence after death. These are often referred to as "will trusts" because they can be created by a person's will. The important point to note is that advance planning is required to include a trust in a will; the intestacy rules which govern who benefits from a person's estate if they without a will are unlikely to make adequate provision if a trust structure is desired.

Trusts can be administered informally

Many individuals appoint family members as trustees, who often view the trust informally or, worse, ignore the trust altogether. Trustees act in a fiduciary capacity and are subject to strict legal duties owed to the beneficiaries and third parties such as HM Revenue and Customs. Failure to comply with those duties can result in personal liability for the trustees, with professional trustees held to an even higher standard of care.

Trustees have a legal duty to invest trust assets subject to strict investment criteria and must take suitable financial advice. Once the trust fund is invested, the trustees have ongoing obligations to keep investments under review and take action if appropriate.

Trustees do not have total unrestricted ability to do whatever they want with trust assets. They are limited by the powers given to them by statute and in the trust deed. A poorly drafted trust deed could mean that trustees are not able to take certain action.

Where appropriate, the appointment of a professional trustee will mean that a trust is administered robustly even though this will incur ongoing administrative costs. Reasonable costs are justifiably incurred and payable out of the trust fund and can give trustees and beneficiaries peace of mind that the trust is being administered correctly.

Beneficiaries should be the trustees

There is generally nothing preventing a beneficiary acting as a trustee, but it is not always appropriate. Beneficiaries have a vested interest in the trust fund which may cloud their judgment. Having family members or beneficiaries acting a trustees can cause tension and disagreements, and because trustee decisions usually have to be unanimous, one dissenting trustee can cause a complete stalemate. It is usually advisable to have at least one independent trustee, who can give an impartial view.

If a trustee-beneficiary is appointed, robust administrative provisions may be needed if they are to be able to benefit from the trust fund. Many older trust deeds, or those which have been poorly drafted, may prevent a trustee-beneficiary from receiving any financial provision from the trusts unless at least one independent trustee is also involved.

For those looking to set up a trust, or trustees faced with the administrative burden of managing a trust, our team of experts can assist.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.