What Is a Trust? How Trusts Work in the UK

What is a trust? In simple terms, a trust is a legal arrangement in which assets are managed by one or more trustees for the benefit of other people, known as beneficiaries. Trusts can hold assets such as money, property, investments and shares and are commonly used for family wealth management, estate planning and protecting assets for particular beneficiaries.

Understanding how trusts work is important because legal ownership and beneficial entitlement can be separated. Trustees are responsible for managing the trust assets according to the trust terms, while the beneficiaries are the people who may receive income, capital or other benefits from those assets.

Trusts UK rules can also create tax and HMRC reporting responsibilities. The exact position depends on the type of trust, the assets involved and how money or property enters, remains within or leaves the trust. These rules sit within the wider Inheritance Tax and estate planning framework explained in our ultimate guide to personal tax in the UK.

This guide explains the basic structure of a trust, the roles of settlors, trustees and beneficiaries, common types of trusts and the main tax and compliance considerations.

What is a trust?

A trust is a legal relationship under which trustees hold and manage assets for specified beneficiaries or another defined purpose.

The person who places assets into the trust is known as the settlor. The people responsible for looking after those assets are the trustees, while the people who may benefit from the trust are known as the beneficiaries.

Assets transferred into a trust can include:

• Cash and savings.
• Property and land.
• Shares and investments.
• Business interests.
• Other valuable assets.

A key feature of a trust is the distinction between legal ownership and beneficial interest. Trustees normally hold legal title to the trust property, but they must deal with it in accordance with the trust terms for the benefit of the beneficiaries.

How does a trust work?

To understand how trusts work, it helps to consider the relationship between the settlor, trustees and beneficiaries.

For example, a parent might place investments into a trust for their children. Trustees then become responsible for managing those investments under the terms of the trust. Depending on the trust structure, the children may become entitled to income, capital or both either immediately or at a later date.

The trustees cannot simply treat trust property as their own. They have legal responsibilities and must follow the terms under which the trust was created.

Who is involved in a trust?

The settlor

The settlor is the person who establishes the trust and transfers assets into it.

The settlor will normally determine important elements of the arrangement when the trust is established, including which assets are transferred, who may benefit and how much discretion the trustees have.

Transferring property into a trust is commonly referred to as settling property or making a settlement.

The trustees

Trustees are the legal owners responsible for administering the trust property.

Their responsibilities can include:

• Managing trust assets.
• Following the terms of the trust.
• Making permitted distributions to beneficiaries.
• Maintaining appropriate financial records.
• Completing applicable HMRC registrations and tax reporting.
• Paying tax liabilities for which the trustees are responsible.

Depending on the arrangement, there may be one trustee or several trustees. A trustee can also be an individual or, in some circumstances, a corporate trustee.

The beneficiaries

Beneficiaries are the individuals or other persons entitled or potentially entitled to benefit from the trust.

Their rights depend on the type of trust. One beneficiary might have an immediate right to trust income, while another trust may give trustees discretion over which beneficiaries receive distributions and when.

What assets can be held in a trust?

Trusts can potentially hold many different types of assets, including:

• Residential and commercial property.
• Cash.
• Investment portfolios.
• Company shares.
• Business assets.
• Land.

The type of asset matters because transferring property into or out of a trust can have tax consequences. Trustees may also have different administrative responsibilities depending on what the trust owns. Where a trust holds farmland or other agricultural assets, the separate overview of IHT Agricultural Relief should also be considered.

Common types of trusts in the UK

There are several types of trusts UK families and estate planners may encounter. The rights of beneficiaries and responsibilities of trustees vary considerably between them.

Bare trusts

Under a bare trust, the beneficiary generally has an immediate and absolute right to the trust capital and income once they are legally capable of taking ownership.

The trustees hold the assets on the beneficiary’s behalf but normally have limited discretion over who ultimately receives them.

Interest in possession trusts

An interest in possession trust gives a beneficiary an immediate right to receive income generated by the trust or otherwise enjoy specified trust property.

For example, one beneficiary may be entitled to income during their lifetime, while the underlying capital ultimately passes to other beneficiaries.

Discretionary trusts

A discretionary trust gives trustees greater flexibility over how trust assets or income are distributed among a defined group of potential beneficiaries.

Depending on the trust deed, trustees may decide which beneficiaries receive distributions, how much they receive and when payments are made.

This flexibility can be useful for families whose beneficiaries have different or changing financial needs, but discretionary trusts can also involve additional tax and administrative considerations.

Will trusts

A trust can also be created through a person’s will and take effect following their death.

Will trusts may be used to provide for a surviving spouse, manage assets for younger beneficiaries or control how inherited assets are held and distributed after death.

Why are trusts used for estate planning?

Trusts for estate planning can be used for several reasons beyond simply reducing tax.

A trust may help:

• Manage assets for children who are too young to control them directly.
• Provide for a surviving spouse while preserving assets for future beneficiaries.
• Manage wealth for beneficiaries who need additional support.
• Control when and how beneficiaries receive assets.
• Provide continuity in the management of family assets.

However, placing assets into a trust does not automatically remove them from consideration for Inheritance Tax. The tax consequences depend on the type of trust, the nature of the transfer and the settlor’s circumstances. Where a trust holds qualifying business assets, Business Relief for Inheritance Tax may reduce the value transferred, subject to its own separate conditions.

How are trusts taxed in the UK?

Trust tax UK rules depend heavily on the type of trust and the transactions taking place.

Taxes that can potentially apply include:

• Income Tax on income generated by trust assets.
• Capital Gains Tax when trustees dispose of assets or when certain assets are transferred.
• Inheritance Tax when assets are placed into certain trusts and, depending on the structure, during the life of the trust or when assets leave it.

The person responsible for reporting and paying tax can also vary. In some cases trustees are responsible, while in others tax consequences may arise for the settlor or beneficiaries.

For this reason, a trust should not be assumed to provide an automatic tax advantage. Its legal purpose and tax consequences should be considered together before assets are transferred. This is particularly relevant following the recent changes to Agricultural and Business Property Relief, which affect trusts holding qualifying assets.

When does a trust need to be registered with HMRC?

Many trusts need to be registered through HMRC’s Trust Registration Service (TRS).

Registration is not limited to trusts that have a tax liability. Many UK express trusts are required to register even where they do not currently owe UK tax, although specific exclusions apply.

Whether registration is required depends on factors including the type of trust, when it was created and whether it falls within one of the exclusions from registration.

Trustees should therefore check the TRS requirements rather than assuming that registration is unnecessary simply because the trust has no tax to pay.

Responsibilities of trustees

Becoming a trustee creates genuine legal and administrative responsibilities.

Depending on the trust, trustees may need to:

• Understand and follow the trust deed or will.
• Protect and appropriately manage trust assets.
• Keep accurate financial and distribution records.
• Maintain information about settlors and beneficiaries.
• Register or update the trust with HMRC where required.
• Prepare tax returns and pay applicable taxes.
• Make decisions fairly and within the powers given to them.

Trustees should not regard trust assets as their personal property. Their authority comes from the trust arrangement and must be exercised for the purposes and beneficiaries specified by it.

Common misunderstandings about trusts

Several misconceptions can cause problems when trusts are established or administered.

• A trust automatically avoids Inheritance Tax: this is not necessarily the case, and it’s worth checking what qualifies for IHT Business Relief before assuming any qualifying business assets are automatically protected. Transfers into and out of trusts can themselves have IHT consequences.
• Trustees own the assets personally: trustees hold legal ownership but must administer the assets according to the trust terms.
• Every beneficiary has immediate access: beneficiary rights depend on the type and terms of the trust.
• A trust only needs HMRC registration when tax is due: many non-taxable express trusts can also fall within the Trust Registration Service requirements.
• All trusts work in the same way: bare, discretionary, interest in possession and other trusts can have very different legal and tax consequences.

Understanding the structure before creating or administering a trust can prevent incorrect assumptions from developing into tax or compliance problems later.

Key takeaways

What is a trust? It is a legal arrangement under which trustees hold and manage assets for beneficiaries or another specified purpose. The settlor establishes the arrangement, trustees manage the assets and beneficiaries receive or may become entitled to benefits according to the trust terms.

Understanding how trusts work requires recognising the distinction between legal ownership and beneficial entitlement. It also means understanding that different types of trusts give trustees and beneficiaries different rights and responsibilities.

Trusts for estate planning can help families manage property and wealth across generations, but they also create legal, tax and administrative obligations. Income Tax, Capital Gains Tax, Inheritance Tax and HMRC registration requirements may all need to be considered depending on the trust.

Before establishing a trust or taking responsibility as a trustee, the purpose of the arrangement, beneficiary rights and applicable trust tax UK requirements should therefore be clearly understood.

Case Study: Setting Up a Family Trust With Clear Tax Responsibilities

Helen approached our Wimbledon office while considering placing an investment portfolio into a trust for her two children. She wanted the assets to be professionally managed until her children were older but was unsure how a trust would affect ownership, taxation and her family’s longer-term estate planning.

Cigma Accounting helped Helen understand the roles involved before assets were transferred. As the settlor, she would place the investments into the trust, while the appointed trustees would become responsible for managing them according to the trust terms. Her children would be the beneficiaries, but their entitlement to income or capital would depend on the type and terms of the trust.

We also reviewed the potential Income Tax, Capital Gains Tax and Inheritance Tax consequences of transferring and holding investments through a trust. This was important because establishing a trust does not automatically remove assets from the IHT position or provide a tax advantage.

Our team also explained the trustees’ ongoing accounting and HMRC responsibilities, including whether registration through the Trust Registration Service would be required, maintaining financial records and dealing with applicable tax returns. Alongside the trust review, Cigma Accounting considered Helen’s personal tax, investment taxation and wider estate planning position.

Helen could then discuss the legal structure with her solicitor with a clearer understanding of how the trust would operate, what responsibilities the trustees would assume and the tax and reporting obligations that needed to be considered before transferring the investments.