Family Trusts Explained: Protecting Assets for Future Generations

A family trust can protect assets from various risks—divorce, bankruptcy, imprudent spending—while ensuring your wealth benefits future generations. But which type of trust is right for your family?

What Is a Family Trust?

A family trust is a legal arrangement where you transfer assets to be managed by trustees for the benefit of your family members. The trust document sets out who can benefit (beneficiaries) and how.

Family trusts serve several purposes:

• Protecting assets for future generations
• Providing for children until they're mature enough to handle money
• Looking after vulnerable family members
• Keeping assets in the family in case of divorce
• Managing inheritance tax

Types of Family Trusts

Discretionary Trusts

With a discretionary trust, trustees decide who receives what and when from a class of beneficiaries. This provides maximum flexibility and protection.

Best for:

• Families wanting flexibility as circumstances change
• Protecting assets from beneficiaries' creditors or divorcing spouses
• Providing for children with uncertain futures

Considerations:

• Subject to the relevant property regime for IHT (10-yearly charges)
• Higher ongoing tax rates on income and gains
• Trustees have significant responsibility

Interest in Possession Trusts

These give one beneficiary the right to income or use of assets (the "life tenant"), with the capital passing to others when they die.

Best for:

• Providing for a spouse while ultimately benefiting children
• Second marriages where you want to protect children from first marriage
• Ensuring income for someone while preserving capital for others

Bare Trusts

Assets are held for a named beneficiary who has an absolute right to them. Often used for children until they reach 18.

Best for:

• Simple gifts to children with tax efficiency
• Junior ISAs and children's savings
• When you're happy for the beneficiary to have full control at 18

Protecting Children's Inheritance

One of the most common reasons for a family trust is ensuring children don't receive large sums before they're ready.

Age-Related Distribution

Your trust can specify that children receive their inheritance in stages:

• One-third at 21
• One-third at 25
• Remainder at 30

This allows young adults to learn financial responsibility with smaller amounts before receiving the full inheritance.

Discretionary Distribution

Alternatively, trustees can have complete discretion over when and how much to distribute based on each child's:

• Maturity and financial responsibility
• Needs (house deposit, education, starting a business)
• Personal circumstances (career, relationships, health)

Protection from Third Parties

A properly structured trust can protect inheritance from:

• Divorce: Trust assets generally don't form part of the matrimonial pot
• Bankruptcy: Creditors cannot easily access discretionary trust funds
• Poor decisions: Trustees act as guardians against impulsive spending

Trusts for Vulnerable Beneficiaries

If a family member has a disability, mental health condition, or other vulnerability, a trust can provide ongoing support while protecting means-tested benefits.

Disabled Person's Trust

Special tax treatment is available for trusts where the principal beneficiary is disabled. Benefits include:

• Treated like a bare trust for IHT (no 10-yearly charges)
• Income taxed at beneficiary's rates, not trust rates
• Capital gains tax at personal rates

Protecting Benefits

A discretionary trust can be structured so that distributions don't affect means-tested benefits like Universal Credit or housing support. Trustees can pay for extras without giving cash directly.

Trusts for Second Marriages and Blended Families

Family trusts are invaluable when you want to provide for a second spouse while ensuring children from a previous relationship inherit.

Life Interest Trust (Right to Reside)

Common in second marriages:

• Your spouse has the right to live in the family home for life
• On their death, the property passes to your children
• Protects children if the surviving spouse remarries or needs care

Flexible Life Interest Trust

Goes further by allowing trustees to:

• Terminate the life interest if circumstances require
• Make capital advances to the surviving spouse or children
• Adjust to changing family circumstances

Setting Up a Family Trust

Lifetime Trusts vs Will Trusts

Lifetime trusts are created during your lifetime:

• Immediately effective
• May have IHT implications if you don't survive 7 years
• Good for removing growth from your estate

Will trusts come into effect on your death:

• Can be changed any time before death
• No immediate tax implications
• Common for protecting children's inheritance

Choosing Trustees

Trustees have significant responsibilities. Consider:

• Family members who know the beneficiaries
• Professional trustees for complex situations
• Having at least two trustees for safety
• Successor trustees in case current trustees cannot act

The Trust Document

A properly drafted trust deed should include:

• Who the beneficiaries are (or the class of potential beneficiaries)
• Trustees' powers and limitations
• How distributions should be made
• What happens to the trust eventually (vesting date)
• Power to add or remove beneficiaries

Tax Considerations

Inheritance Tax

Different trusts have different IHT treatment:

• Discretionary trusts: May face charges when created (if over nil rate band), then 10-yearly charges and exit charges
• Bare trusts: Treated as belonging to the beneficiary for IHT
• Will trusts: Form part of your estate on death but can provide ongoing protection

Income Tax

Trust income is taxed at:

• Discretionary trusts: 45% on income (39.35% on dividends)
• Interest in possession trusts: 20% basic rate
• Bare trusts: Beneficiary's personal rates

Capital Gains Tax

Trusts have an annual exemption of £1,500 (half the personal allowance) and pay CGT at 20% or 28% for property.

Ongoing Trust Management

Family trusts require active management:

Trustee Meetings

Trustees should meet at least annually to:

• Review investments and trust assets
• Consider beneficiaries' needs
• Make distribution decisions
• Record decisions in formal minutes

Tax Returns

Most trusts must register with the Trust Registration Service and file annual tax returns if there's income or gains.

Accounts

Maintaining accurate records of all trust transactions is essential for both tax compliance and good governance.

Costs Involved

Setting up a family trust involves:

• Legal fees: £1,000-£5,000+ depending on complexity
• Ongoing administration: Potentially £500-£2,000 annually for professional trustee services
• Tax returns: £200-£500 annually if professionally prepared

While costs are significant, they're often worthwhile for protecting substantial family assets.

Is a Family Trust Right for You?

Consider a family trust if:

• You have significant assets to protect
• Beneficiaries are young or vulnerable
• You have concerns about divorce, bankruptcy, or imprudent spending
• You have a blended family with competing interests
• You want professional management of family wealth

A family trust might not be necessary if:

• Your estate is modest
• Beneficiaries are mature and financially responsible
• A simple will would achieve your goals

Professional advice is essential to determine whether a trust is the right solution for your family circumstances.