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The ultimate guide to trusts

What is a trust?

A trust refers to a legal relationship created when assets have been placed in the control of a third party for the benefit of another person or for a specified purpose. This separates the control of the assets from the right to the value of the assets.

Who are the people involved in a trust?

The settlor creates the trust. A settlor can create a trust either by declaring that they hold certain assets on trust for the beneficiaries or by transferring the legal title to assets to trustees for them to hold for the beneficiaries.

Trustees are the third party who hold the legal title to the trust assets. Trustees have both powers and duties to deal with the trust assets in accordance with the terms of the document which creates the trust. The exact way in which trustees are expected to deal with the assets depends on the type of trust. More information on the various types of trust can be found here. For large trusts, trustees will often be professionals, such as wealth managers or lawyers.

Trustees hold assets for the beneficiaries of the trust. The interest that a beneficiary has in the trust will depend on the type of trust that has been established. For example, a beneficiary may be entitled to income and/or capital from the trust assets.

Protectors may be appointed to oversee the administration of a trust. The settlor determines the exact role the protector will hold. A protector could, for example, be given the power to appoint and/or remove trustees. In practice, protectors are often appointed in offshore trusts. Whether a protector can be appointed will depend on the rules governing where the trust is based.

What are the different types of trust?

Trusts can be created expressly by the settlor (‘express trusts’). They can also be inferred from the way assets are held in certain circumstances. This document deals solely with express trusts.

There are two types of express trust:

  • Fixed trusts: where the beneficiaries are identified.
  • Discretionary trusts: where the choice of beneficiaries is left to the trustee(s), subject to the terms of the trust deed.

In a fixed trust, the settlor chooses the beneficiaries and determines what income or capital they can receive from the trust. For example, one beneficiary could be entitled to the income generated by the trust assets, whereas another beneficiary could be entitled to the capital of the trust assets.

In a discretionary trust, the trustee has the power to decide how the trust’s assets and income are distributed. They will be under a duty to exercise their discretion to apply the trust assets with reference to the trust instrument and any other relevant documentation. This could be a letter of intention created by the settlor, which sets out the matters he wishes the trustees to have in mind when they exercise their discretion. If a trustee, for example, breaches a duty, they can usually be sued by any of the beneficiaries of the trust.

Trusts can be revocable or irrevocable. Revocable trusts allow the settlor to alter the terms of the trust, or cancel it, within their lifetime. By contrast, the settlor of an irrevocable trust cannot alter or cancel the trust. These distinctions are important as, for example, the tax treatment of a trust differs depending on whether the trust is revocable or irrevocable.

How do you set up a trust?

Setting up a trust is a complex process. Initially, the settlor must define the purpose of the trust. If, for example, the settlor wishes to provide his spouse with an income during the spouse’s lifetime but then on the spouse’s death provide capital to his children, a simple fixed trust would be appropriate. Alternatively, if the settlor wished to provide a mixture of capital and income to the same persons then a discretionary trust may be more appropriate.

Next, all of the practicalities and formalities involved in setting up the trust must be considered. This includes deciding who will act as trustee, drawing up the trust instrument and any supporting documentation, and ensuring that these are legally binding (if the settlor fails to sign the trust agreement, for example, the trust would be invalid).

Most commonly, the trust will come into existence when the settlor first transfers assets to the trustees to hold for the beneficiaries.

How does a trust end?

Trusts automatically come to an end when no assets remain. This can happen, for example, when under a fixed trust, the trustees pay out the capital of the assets to a beneficiary. Alternatively, the assets held in a discretionary trust may be exhausted because the trustees have exercised their discretion and decided to pay out all of the assets to the beneficiaries.

There are other less common ways in which a trust can come to an end:

  • If the beneficiaries of the trust are consenting adults with capacity they are entitled to request that the trustees pay out all of the assets. This can be achieved without the court's assistance. 
  • If the court decides to exercise its power to vary the trust.
  • If the trust instrument has been improperly prepared, e.g. by failing to specify to whom certain trust assets should be paid, preventing the trustees from distributing some or all of the assets. In such circumstances, the trustees will hold the trust assets on a resulting trust for the benefit of the settlor.

Forward planning is important before a trust is brought to an end, so as to be aware of any difficulties that may arise, such as adverse tax implications.

Can you change the terms of a trust?

At a point during the lifetime of a trust, it may become desirable to vary its terms. Whilst the general rule is that trustees are duty-bound to carry out the settlor’s wishes, in certain circumstances a trust can be varied either with or without the court’s assistance.

It is possible that the trust instrument will have been drafted in such a way so as to provide the trustees with the power to effect a variation without the need for a court application. In the absence of any such express powers, where the beneficiaries are all adult, all able to understand the nature and consequence of their acts, and are all entitled to all of the trust assets, then the beneficiaries can agree to bring the trust to an end. The beneficiaries can then – if they wish – create a new trust on different terms. Alternatively, the same beneficiaries could together consent to any act done by the trustees which has the effect of varying the trust.

It may be that the trust cannot be varied without the court’s assistance. While the general rule is that the court has no power to vary the terms of a trust that is clearly expressed and valid, there are some limited exceptions. On divorce, for example, if the court finds that the trust has a nuptial element then it may order a variation of the trust.

What are offshore trusts and foundations?

Offshore trusts and private foundations are complex structures used to hold wealth.

Offshore trusts are located in a no or low-tax jurisdictions (e.g. Bermuda, the British Virgin Islands, or the Isle of Man). With offshore trusts, there can be difficulty with obtaining disclosure from the trustees or enforcing any order made by the English court.

Private foundations are legal entities established for the benefit of their founders. A council or board will run the private foundation. Unlike a trust and more akin to a company, a private foundation can hold assets in its own name. Some features are common to all private foundations, they can all last for an unlimited duration, for example. The exact nature of a foundation will, however, differ depending on the jurisdiction within which it is located.

The court is growing increasingly accustomed to dealing with such structures. In certain circumstances on divorce, both offshore trusts and private foundations can be taken into account by the court when assessing the nature and extent of the parties’ wealth. Whether or not an order resulting from this exercise can be enforced is, of course, another matter.