Will trusts and lifetime trusts

What is a will trust?

Trusts are legal entities that allow someone to benefit from an asset without being the legal owner.

A will trust is created within your will to allow you to protect property you hope to pass on to your family.

You create the trust and appoint people to manage it - the 'trustee', on behalf of the 'beneficiaries' - who receive the benefit of the assets of the trust.

Establishing a trust can give you an element of control over assets you wouldn't have if you gave them away outright. There can also be tax advantages, but that should never be the main reason for setting one up. In some cases, you could end up paying more tax by putting assets into trust.

Trusts can be complicated structures with tax implications, and you should always seek legal advice before setting one up.

There are two main types of trust that you might choose to set up: a will trust, created upon your death, or a lifetime trust, which you establish during your lifetime. We explain the pros and cons of both.

Leaving property in a will trust

Unlike a lifetime trust, you set up the conditions of the trust in your will and it activates upon your death.

Will trusts are mainly used by couples to deal with the family home if they own it as 'tenants in common'. Rather than leaving their share to each other outright, they each leave it to a trust, which comes into being on the death of the first partner.

Until recently, more complex will trusts were a common way of saving on inheritance tax (IHT). A couple potentially liable for IHT could split their estate into halves, both below the nil-rate band.

However, since 2007, depending on certain conditions being met married couples and civil partners have been able to transfer the unused IHT allowance to one another. As such, most couples no longer need to make this type of trust for inheritance tax purposes, though it may be used to potentially ring-fence the deceased spouse's share from care home assessments.

• Find out more: inheritance tax on property

Will trusts and long-term care

If you use a will trust, which concerns the family home, and your partner dies, you as the surviving spouse retain a 'life interest' - a right to live in the house, and benefit from the income from any sale proceeds should the property need to be sold. If you need to pay for care, potentially only your share of the home's value will be assessed by the local authority.

The part owned by the trust is usually not counted. In this way it can be protected from care home costs. Government rules (Charging for Residential Accommodation Guide) suggest that this arrangement will not be contested as 'deliberate deprivation', meaning that you have deliberately split your assets to avoid paying high care home fees.

• Find out more: how to avoid inheritance tax - this guide explores a range of ways you can reduce the amount of tax due on the transfer of your estate.

Will trusts and inheritance

Another reason for setting up a will trust is to avoid 'sideways disinheritance'.

This occurs when the first partner dies, leaving children from the marriage who might reasonably expect to inherit some of the family estate when both spouses have died. If the surviving partner remarries and fails to make provision for their children in a new will, there's a risk that everything will go to their new spouse instead.

To avoid this situation, you could set up a life interest trust in your will, which leaves your share of the family home to your children, while allowing your spouse to carry on enjoying the right to live the property.

You should seek legal advice before pursuing this option.

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Lifetime trusts

Lifetime trusts are often known as property protection trusts or asset protection trusts. Unlike will trusts, which come into being on your death, lifetime trusts usually are established straight away. For example, your home is gifted to the trust, which allows you to carry on living in it.

It is generally not possible to use a lifetime trust to exempt your home from the local authority's calculations of your assets, when assessing your care home costs.

Anyone considering setting up a lifetime trust, for this reason, should be aware that a local authority may regard this arrangement as 'deliberate deprivation of assets'. If this is the case, they can assess you as if you still owned the property (and refuse to fund your care).

• Find out more: care home fees explained

Lifetime trusts and tax

The tax treatment of lifetime trusts is worth considering carefully. Because you gift the house to the trust, it can attract inheritance tax if it's worth more than the nil-rate band (currently £325,000).

Those who transfer their property to a lifetime trust may face an immediate 20% charge on any balance over £325,000 (including gifts made in the previous seven years), while the trustees must submit tax accounts to HMRC. They may have a further tax bill every 10 years, worth 6% of the value over £325,000, plus income tax on any payments from the trust, plus exist charges on assets that leave the trust. 

If the trustees sell assets within a trust or transfer them to a beneficiary, these may also be subject to capital gains tax. These may also apply if a trust is liquidated and everything is passed to a beneficiary.

Capital gains tax will be calculated in a similar way as it is for individuals, the exception is if the trust has been set up for someone disabled.

You must also consider that all trusts created must be registered with HMRC. If created in your lifetime, when the trust comes into existence, and if created in your will, after you have died, as part of the administration of your estate.

It's always important to seek advice before setting up a lifetime trust, as the tax implications can be significant. This is especially true if the beneficiaries of the trust aren't UK residents, as the rules can quickly become even more complicated.

• Find out more: trusts and inheritance tax

Discretionary trusts

Will trusts and lifetime trusts can be structured in one of two ways:

• fixed interest, where the first beneficiary has an absolute right to stay in the house and receive the income from any trust investments; or
• discretionary, where the trustees have a pool of potential beneficiaries and have a discretion how to benefit any of the potential beneficiaries.

Usually a discretionary trust also has a letter of wishes for the trustees to consider, which may give one beneficiary the trustees' permission to live in the house or receive the income from investments. The tax treatment of fixed interest trusts is different from discretionary trusts.

• Find out more: how to write life insurance into a trust?

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