What Is a Trust Fund and How Do They Work?

Saturday 27 May 2023

Written by Paul Dell

What Is a Trust Fund and How Do They Work?

What Is a Trust Fund and How Do They Work?

A trust fund is a financial arrangement where a person (the settlor) transfers assets to a trustee(s) to hold on behalf of a beneficiary. The trustee(s) manage the assets for the benefit of the beneficiary, according to the terms of the trust deed. Trust funds are commonly used to provide financial support for minors, charitable organisations, and other beneficiaries who are unable to manage their own affairs, as well as for asset protection and estate planning

In the UK, there are different types of trust funds, including bare trusts, interest in possession trusts and discretionary trusts. Each type has its own unique features and benefits, so it's essential to understand the differences before choosing the right one for your needs. Each type has different tax treatments on income and capital, so it’s important to seek professional advice on such matters for your individual circumstances.

Bare trusts are the simplest type of trust fund, where the beneficiary has an immediate and absolute right to the assets held in the trust. This type of trust fund is commonly used to hold assets for minors who can only access the assets when they reach the age of majority. It’s effectively a “look-through” trust, and from a tax perspective, the beneficiary is treated as owing the assets and receiving the income

Interest in possession trusts gives the beneficiary (the life tenant) an absolute right to receive the income generated by the assets held in the trust while the capital remains intact for the future benefit of other beneficiaries. This type of trust fund is commonly used to provide for a surviving spouse or partner and is a common principle in wills; with the assets eventually passing to other beneficiaries upon their death.

Discretionary trusts give the trustee the discretion to decide how the income and assets in the trust are distributed to the range of beneficiaries. This type of trust gives the greatest asset protection and flexibility in terms of tax planning, as income can be paid to lower tax paying or non-tax paying beneficiaries to recover any tax paid by the trustees. There are also other reliefs available (hold over relief for capital gains tax for example) when assets are transferred into the trust.  These types of trust are used extensively In estate planning to mitigate Inheritance Tax (IHT). The tax issues around discretionary trusts can be complex and again it’s important to seek professional advice tailored to your individual circumstances.

Trusts are a useful wealth management tool that can provide financial support for beneficiaries who are unable to manage their own assets, as well as providing asset protection benefits and assisting  with IHT planning .

If you're thinking about setting up any form of trust, it's essential to seek professional advice to ensure that you choose the right type of trust fund for your specific needs. With the right help, you can ensure that your trust fund is set up correctly and will provide the support and benefits you need for years to come.

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