Investments  

How wills and trusts work

  • Describe how trusts work
  • Explain how wills work
  • Identify the importance of Lasting Powers of Attorney
CPD
Approx.30min
How wills and trusts work
 Pexels/Andrea Piacquadio

When I started in financial services years ago, one of the biggest issues with protecting clients was not doing enough to place policies in trust, and to set up wills and powers of attorney. Fast forward nearly 30 years, and little has changed.  

The problem usually lies in an adviser’s knowledge, skills or behaviours. 

What is ‘knowledge’? 

Knowledge is an individual’s understanding of a subject, gained from studying a qualification or with regular continued professional development. Having the knowledge about something does not necessarily mean you can do it, only that you understand the steps involved.

So let’s refresh our knowledge on these important subjects, starting with trusts – also known as ‘settlements’. 

Trusts are a way for the owner of an asset (the settlor) to distribute or use that asset for the benefit of another person or persons (the beneficiaries) without allowing them control over the asset while it remains in trust. 

The settlor creates the trust and originally owned the assets placed in the trust (the trust property). But the settlor no longer owns the asset once it is placed in trust, unless the settlor is also a trustee. 

Depending on the nature of the trust, the beneficiaries may eventually become the absolute owners of the asset. They may be named individually or referred to as a group, for example, ‘all my children’. 

The settlor appoints trustees to take legal ownership of the trust property and administer it under the terms of the trust deed. The trustees, who can include the settlor, are named in the trust deed. Trustees must be aged 18 or over and of sound mind. If a trustee dies, the remaining trustees, or their personal representatives, can appoint a new trustee. 

Trustees have several duties. They must:

  • act in accordance with the terms of the trust deed. (If the trust deed gives them discretion to exercise their powers, the agreement of all the trustees is required before a course of action can be taken) 
  • act in the best interests of the beneficiaries, balancing fairly the rights of different beneficiaries if these should conflict 
  • be aware of the need for suitability and diversification of assets. 
  • obtain and consider proper advice when making or reviewing investments.
  • keep investments under review.

Types of trust

1. Bare trusts

Assets in a bare trust are held in the name of a trustee. The beneficiary has the right to all the trust’s capital and income at any time if they are 18 or over in England and Wales, or 16 or over in Scotland. 

This means the assets that the settlor has set aside will always go directly to the intended beneficiary. Bare trusts are often used to pass assets to young people. The trustees look after them until the beneficiary is old enough.

2. Interest in possession trusts

These are trusts where the trustee must pass on all trust income to the beneficiary as it arises, less any expenses.

3. Discretionary trusts

Trustees can make decisions about the way trust income and sometimes capital is used. Depending on the trust deed, trustees can decide:

  • who to make payments to
  • what gets paid out – income or capital
  • frequency of payments
  • conditions imposed on beneficiaries.

Discretionary trusts can be used to put assets aside for:

  • a future need, such as a potential beneficiary such as a grandchild not yet born
  • beneficiaries who do not have the capacity to look after themselves financially.

4. Accumulation trusts

This is where the trustees can accumulate income within the trust and add it to the trust’s capital. They may also be able to pay income out, as with discretionary trusts.

5. Mixed trusts

These are a combination of more than one type of trust. The different parts of the trust are treated according to the tax rules that apply to each part.