It’s session number 22 , and we’re going to be talking about Trusts. If there’s an area of financial planning that is misunderstood, then it is trusts. I think I may have said that about pensions too, though! I’d go so far as to say that there are many advisers who don’t understand trusts as they should. But they are a key financial planning tool. Wealthy families understand the power of trusts to protect the family money across the generations, but ordinary people like you and me can also benefit from using trusts in certain circumstances.
We’ve got two questions from listeners Matt and Richard about trusts which I’ll play at the end of the show and answer, so stay tuned for that.
Click to Listen
This podcast is brought to you with the help of Seven Investment Management, a firm of investment managers based in London. They put their name to my show and to my site and videos because they believe in what I’m doing, and I’m very grateful for their support. You can see what they’re up to at 7im.co.uk
So, trusts are useful tools, but what is it about them that means they are so misunderstood? I think they have a certain mystique because they are not quite like anything else. I know that for a while, early on in my career, I couldn’t really get my head around the fact that they are a separate legal entity in their own right. It wasn’t until I sat higher level exams, and began working for a firm of solicitors, that the theory needed to be applied – then you learn pretty quick!
So let me see if I can clarify things for you and give you what you need to know about trusts for 90% of cases, and then the things you need to do if you’re considering setting up a trust for your own needs.
Everything you need to KNOW
So, let's deal with everything you need to know about trusts, first.
1 – What, who and how
As I just said, a trust is a separate legal entity. So the courts and HM Revenue & Customs see a trust as a distinct body under law. There are specific laws pertaining to trusts, the Trustee Act 2000 being the main one, and a trust has its own tax allowances and rules which only apply to trusts.
For our purposes, think of a trust as a box. Into the box you can place things, pretty much anything, such as investments, property, probably even my dog, should I want to! On the box are some written instructions as to how the things in the box should be looked after, and also instructions as to when the box should be opened, and to whom the contents should be distributed.
There are three parties involved in setting up and running a trust
- Settlor – sets up the trust and gives the instructions as to how it should be run in the future
- Trustees – look after the trust and follow the settlor’s wishes within the laws pertaining to trusts
- Beneficiaries – those who receive the benefit of the trust property, the things in the box
All trusts are set up via a written trust deed. This can either be stand-alone, or part of someone’s will. The document needs to be signed, witnessed and dated in order to be valid.
So for example, a trust deed might say the following:
“I, Pete Matthew declare a trust to be created called the MeaningfulMoney Trust. Myself and my wife Joanne are to be the trustees. Into the trust we place the sum of £100,000. The beneficiaries are to be our children, Ellie & Kate, and they are to benefit from the trust property when they reach age 25”
So in this case, I am the settlor. It’s my trust and I’m calling the shots about its setup and the point of its existence.
Jo and I are trustees – the settlor is normally a trustee unless the trust is being set up by a will, in which case the settlor is dead, obviously. Throughout the life of the trust, she and I would make decisions about how to invest the money held within the trust for the benefit of our children. Then we would make sure that the money is paid out to our children when they each reach age 25. So far, so simple.
I could make the trust more flexible by instead of naming my children, using the phrase “my children or remoter issue” and giving my trustees the power to choose which child benefits and when. Remoter issue can mean grandchildren, or step-children, even the future spouses of my children. Trusts have to be worded carefully, usually in technical legal language, to avoid any doubt about who can benefit. There are an infinite number of permutations as to how a trust can be worded which means it should be possible for you to be very specific, and to get your exact wishes carried out
2 – Powers and duties of trustees
Trustees have certain powers and duties which they are bound by, under law. Here are the main ones in summary:
Power of investment – unless the trust deed specifically limits a trustee, he can “make any kind of investment that he could make if he were absolutely entitled to the assets of the trust”. This is important as it opens up pretty much any kind of investment for the trust to hold. This power comes with duties though:
- Duty to exercise skill and care – this takes account of a trustees professional status, so I would be held more to account given my professional adviser status than a lay trustee
- Duty to take account of standard investment criteria – these criteria, when it comes to trust are to make sure any investment chosen is suitable, and to make sure the money is diversified, that is, spread around.
- Duty to keep investment under review – trustees should have regular meetings to make sure the chosen investments continue to be the best choice for the trust
- Duty to take advice – if a trustee is not a qualified adviser, they should seek advice form an expert as to the best course of action
Power to delegate – a trustee can delegate some of his or her powers to a third party if it is in the best interests of the trust. This might mean instructing a discretionary fund manager to look after the day-to-day management of the funds. Obviously the delegate should be qualified and able to do the job. The trustee remains responsible for the actions of the delegate
Duty to ensure fairness between beneficiaries – if there is more than one beneficiary, then the trustees are bound to make sure they are both considered equally. I quite often come across the scenario where an old fella has died and set up a trust in his will. His widow gets an income produced by the trust investments and his children eventually get the capital when she dies. The widow is called the Life Tenant of the trust, and she can never touch the capital, but only the income from it. Likewise the children, called the Remaindermen, get nothing at all until the widow dies. Managing investments in this case is tricky because the trustees cannot favour one class of beneficiary over another. So they can’t opt for growth investments which don’t produce an income because this would only benefit the children. Similarly, the trustees can’t put all the money int he bank, as this will produce an income, but can never grow, so the widow will benefit, but the children will not. There have been high-profile cases where beneficiaries have successfully sued trustees for getting this wrong.
Duty to take account of the settlor’s wishes – This might seem obvious, but a settlor can write a ‘side letter’ to the trustees, giving them some guidance as to his thinking when setting up the trust, hopefully to make their job easier. When making their decisions, trustees must always consider what the settlor would have wanted when he set up the trust.
Duty not to sit on cash – If you’ve listened to this show for a while you know that I’m always saying that cash is not an investment. Turns out the law agrees with me! There have been many cases where trustees were hesitant to invest, and in being so missed out on a rising stock market. Unless money is needed by a beneficiary in the short term, any money held by the trustees should generally be invested
Duty to take account of tax considerations – Again, this should go without saying, but trusts have weird tax rules specific to them, so a trustee needs to know what they are doing. Time doesn’t permit – and you really don’t want – me to go into the specifics of trust taxation. I’d be here for three hours or more, and you’d be bored witless!
All these powers and duties are binding on the trustees, and are not to be taken lightly.
3 – Benefits of trusts
Surely there must be some clear benefits of trusts, or are they just a tangle of rules, duties, powers and taxation quirks? Here are some key benefits:
- Trusts enable specific instructions to be carried out. A well-worded trust can be used to execute the settlor’s instructions, no matter how specific or vague. Conversely, a badly worded trust can cause the trustees problems. If you have a specific set of instructions you want carried out at a specific time, involving specific people, a trust can achieve that for you.
- Trusts are not part of your estate. This means that property inside a trust does not have anything to do with the rest of the estate on the death of the settlor. This can save inheritance tax if planned far enough ahead, and can get money to the people who need it quickly after the death of the settlor, without waiting for probate to be granted.
- Trusts can offer tax savings. Moving money into a trust can help you organise money tax-efficiently. Inheritance Tax is the obvious benefit, but there are others.
- Trusts can ring-fence money against outside influences. Outside influences? Imagine one of your children is married and you leave ‘family’ money to him. If he subsequently gets divorced, some of that family money could leave with the ex-wife. Or maybe that spouse goes bankrupt – money in a trust could be protected from that, depending on the type of trust and its terms.
- Trust can be used to protect money against means-testing. Care is needed here, but one example where trusts can be very useful is if someone suffers a personal injury and receives a payment of monies as compensation. In some circumstances this could scupper their receipt of certain benefits. Trusts can be used to protect benefits in the right circumstances.
So, we’ve learned what trusts are, and how they work. We’ve looked at the powers and duties of trustees, and we’ve taken a very quick look at some of the benefits. But if you are a trustee, or are thinking of setting up a trust – what do you need to DO?
Everything you need to DO
1 – Think very carefully about it, if you are asked to be a trustee
This might sound obvious, given the duties we talked about earlier, but let me put it more definitively for you:
I don’t know why anyone would volunteer to be a trustee unless they were being paid, or had a particular love for the person asking them to be. It is an incredibly onerous responsibility. If things go wrong, and you get sued by the beneficiaries for some reason, you are personally liable. Chances are, it’s not your money, unless you’re also the settlor, so why would you take on the risk of looking after it.
In reality most trustees know the person who is the settlor, and have some kind of vested interest, even if it is only their children, and not themselves who will benefit from the trust. This is what drives them to accept the job of being a trustee. I’d bet good money though that 95% of people who take on a trusteeship have no idea of the duties, powers and responsibilities they are taking on, let alone the extent of their liability.
Are you getting the message? Unless you’re setting up a trust for yourself, think long and hard before agreeing to be a trustee for someone else.
2 – (Almost) Always write life assurance in a trust
Life insurance is too-rarely written in trust. Again, this is because many advisers are unaware of the benefits of trusts or the pitfalls of not writing life insurance in trust. Life assurance generally pays out a lump sum on death, though it can sometimes payout smaller lumps sums over time (see session 7 for more detail). Think of the impact on your family if that payout were just dumped on them. You might think it would be wonderful, and for your particular circumstances it might be the right thing, but you should definitely take advice before making the decision to use a trust or not.
All life insurance companies will provide trust wording which you can use, but you shouldn’t rely on this. Get it checked out by someone who knows what they are doing first.
Be careful if the life insurance policy includes other benefits, like critical illness cover. Some policies payout once on diagnosis of a serious illness, then again on death. If you're alive and poorly, you probably want to have the money yourself, but if you’re dead, the money may be better off in a trust. There are special trusts called split trusts which allow for policies with different kinds of benefits.
3 – Be aware of the taxation of investments, particularly within a trust
Trust are just boxes remember, and in those boxes can be put all kinds of investments and tax wrappers. Each of these different kinds of investment has different rules that apply for income generation, taxation, surrender. Often these have subtly different effects inside a trust than they do for an individual. Or maybe, the rules of the trust might preclude certain investments from being held at all.
For instance, several times I have come across a trust which is supposed to pay an income to a beneficiary, where the trust money is held within an investment bond. The problem here is that Investment Bonds don’t produce an income per se, but instead they throw off capital withdrawals. So the trustees were in breach of trust by investing in the wrong thing. Worryingly, they were probably advised to invest in this way by a financial adviser. Like I said, too many advisers don’t really understand trusts well enough.
A lay trustee can’t be expected to know about that subtle little wrinkle in the law, but they are still liable under law for that mistake, which leads me to the last point…
4 – Use a solicitor
Hopefully you have got the message by now that these trust things are tricky. You should not enter into a trust of any kind without seeking advice from a solicitor, or at the very least from an adviser who knows what they are doing. You can, I’m sure, get kits off the internet for wording a trust. Don’t do it.
Mistakes made in setting up a trust can cost you thousands of pounds. A tax cock-up might not come to light for years after the trust is set up, and maybe years after you can do anything about it. Don’t scrimp on the writing of the trust, and pay for it more dearly later. It might cost you £1000 or more for a decent lawyer to write a comprehensive trust, but it is money well spent.
Hopefully that was helpful, though as ever we’ve barely scratched the surface of what trusts can do for your financial planning.
It’s worth mentioning finally – probably should have mentioned this up front – that everything I say here applies to England & Wales. If you’re in Scotland, there are subtle differences which I just don’t have the time or the knowledge to explain here. The last point applies especially to you then – see a solicitor!
This week we’ve got two questions about this subject – exciting. The first comes from Matt, who you may remember from last week. He emailed me these questions, but I asked him to send them as a voicemail instead so I could answer them for all of you.
When you make a will, you can set up a trust. Does this save going through probate?
Nope, I’m afraid not. A trust set up by a will means the will has to be proven first, which means grant of probate must be received by the executors before they can go about setting up a will trust. The benefits of will trusts are the same as all other trusts, its just that the deed setting them up is someone’s will.
Life assurance policies in trust – what are the benefits?
I mentioned this earlier, but to reiterate, the biggest reasons for writing a life policy in trust are to avoid the amount of the policy being dropped into the estate, which could then attract Inheritance Tax, and also for speed of payout. A life policy owned by a trust has nothing to do with the estate of the person whose life the policy is on.
The next question is from my friend Richard:
If I am the sole trustee on a trust for children, and I die before they become adults, what happens?
Unless there is a specific clause in the trust deed which gives the existing trustee the power to appoint other trustees, you are stuck with this situation. If you die before the child beneficiaries become adults then your personal representatives, your executors, would take on your responsibilities. So choose your own executors wisely. If setting up a trust of your own, it is a good idea to appoint more than one trustee to minimise the chances of the trust suddenly being without a trustee.
That's it for this session of the MM podcast, I hope that was helpful. Any questions? Please leave any comments or questions in the comments below.
If you like what you hear on this podcast, please leave a rating or review on iTunes. This helps others to hear about the show and to subscribe.
I hope you enjoyed this session. Next time we'll be talking about The Five Golden Rules. These will be my foolproof rules for staying on the straight and narrow and which guarantee financial success. If you have any questions about this, go to meaningfulmoney.tv/feedback and leave a voicemail.
Thanks for listening – I'll talk to you next time