The family trust, when used for the right reasons at the right time, can be an effective way of preserving and protecting personal assets for the benefit of loved ones, both during your lifetime and after you die. That said, as with any type of trust, there can also be a number of drawbacks to the family trust.
Below we look at some of the main family trust disadvantages, as well as the available alternatives to using the family trust.
What is a family trust?
The family trust is a legally binding document that covers an individual’s assets and how these are to be distributed, either during that person’s lifetime or upon death. The person transferring those assets into the family trust is called the settlor, whereby the people appointed by the settlor to manage and administer the trust fund are called the trustees.
Those individuals, or class of individuals, nominated to benefit from the proceeds of the trust fund, either by way of income generated from the capital assets, or the assets themselves, are called the beneficiaries.
A family trust can be set up to take effect during the course of the settlor’s own lifetime. This is known as an inter vivos or a living trust. With these types of trust the settlor will typically appoint themselves as a trustee, together with relatives, close family friends or a professional adviser, such as a solicitor or accountant.
The family trust can also be set up, typically within the terms of a last will and testament, to take effect upon the settlor’s death. This is known as a testamentary trust.
In the case of either a living or a testamentary trust, the trust deed will set out how the family trust is to operate, including what benefits will be received, by whom and when.
What are the different types of family trust?
There are several different types of family trust depending on the financial goals of the settlor, including how and when they want the trust fund to be distributed. The main types are as follows:
The bare trust
The bare or absolute trust is the most basic type of family trust. Here, the beneficiary becomes automatically entitled to the trust fund when they attain the age of majority.
As such, bare trusts are often used to hold investments for children and grandchildren until they turn 18, or to bequeath assets following the settlor’s death where the beneficiaries are still minors.
The discretionary trust
The discretionary trust is so called because no beneficiary has a fixed or absolute entitlement to any share in it. Instead, the trustees have some discretion as to how and when any income or capital is distributed, typically to a class of beneficiaries, for example, the settlor’s children or grandchildren.
In this way the discretionary trust can accommodate the birth of additional descendants, so long as they fall into a designated class.
The interest in possession trust
The interest in possession trust has two types of beneficiary: the income beneficiary and the capital beneficiary. The former has an immediate entitlement to any income generated by the trust assets, whereby the latter will become entitled to the trust property at some future point in time.
This type of family trust is typically set out within the settlor’s will to provide an income or a home for the life of their surviving spouse, whilst preserving any capital assets for the settlor’s children upon the death of that spouse.
The mixed trust
A mixed trust combines various features from different types of family trust, for example, the discretionary and interest in possession trusts. In this way, the trust can be tailored to suit the specific needs of the settlor and their family.
This type of family trust can be useful where the settlor wants to make financial provision for a number of descendants, for example, sibling beneficiaries, or other relatives, at different points in time.
What are the family trust advantages?
The family trust can offer a number of advantages, not least ensuring that your loved ones benefit from your personal assets in the way that you intend(ed).
In particular, a settlor can safely pass assets to a child, to be inherited only when that child has reached a certain age, or even to make financial provision for unborn descendants.
The family trust will also enable a settlor to make provision for their surviving spouse, whilst preserving their personal wealth for the benefit of their children at a later date.
Further, under a family trust, the settlor can transfer legal title to their personal assets to protect and preserve those assets, for example, to minimise the extent of any inheritance tax liability after they die, to shield those assets from bankruptcy or divorce, or, where set up correctly, to mitigate the cost of care home fees.
What are the family trust disadvantages?
Unfortunately, and notwithstanding the benefits of the family trust, there are also various drawbacks. The main family trust disadvantages are as follows:
Relinquishing legal title
Inherent within the process when creating a family trust is that the settlor will be required to relinquish legal title to any trust property. As such, any assets transferred into the trust become the legal property of the trustees, to manage on behalf of the beneficiaries in accordance with the terms of the trust deed.
Depending on the nature of the trust, any transfer made to the trust may be treated as irrevocable. In these circumstances, any decision to gift assets, money or investments, will be final.
The settlor, therefore, must be careful about making any irreversible decisions, taking into account the possibility that their own financial circumstances may change, potentially leaving them unable to access any personal assets contained within a trust fund.
Even if you opt to appoint yourself as a trustee, you must, by law, work solely in the interest of the beneficiaries.
Onerous tax implications
Notwithstanding that a family trust can often be used to minimise any potential inheritance tax liability payable on death, the creation of the trust can give rise to additional and immediate tax liabilities including income tax, capital gains tax and even inheritance tax.
When setting up a family trust so as to make tax savings, you should always seek professional advice. The tax advantages can be minimal, whilst creating additional liabilities for trustees and beneficiaries alike.
Deliberate deprivation of assets
If you are found by the local authority to have intentionally decreased your overall assets in order to reduce the amount you are charged towards the cost of care services provided, this will be classed as a deliberate deprivation of assets.
In these circumstances, the local authority will treat you as if you still own the property and bill you on the basis of what’s known as your notional capital. Further, the local authority can take enforcement action against either you, or the person to whom any asset was transferred, in respect of ongoing care fees.
Is there any available alternative to the family trust?
By way of alternative to the family trust, a Family Investment Company, or FIC, can be very beneficial for both inheritance tax planning and asset protection.
An FIC is a flexible structure that can be tailored to suit the needs of your family, allowing you to define how specific individuals benefit through varying rights attaching to shares, or the number of shares in issue.
As with trusts, the FIC enables parents and grandparents, as the likely directors of the company, to retain control over assets, whilst accumulating wealth in a tax-efficient environment and facilitating future succession planning.
Seeking legal advice for family trusts?
Exploring ways of protecting and preserving your personal assets can be confusing. It is always best to seek expert legal advice when considering estate planning or asset protection through a family trust, especially when considering any family trust disadvantages.
In this way, your legal adviser can draft the terms of a family trust tailored to suit your needs, or talk you through the alternatives, including the benefits of an FIC.
The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal advice, nor is it a complete or authoritative statement of the law and should not be treated as such.
Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission.
Before acting on any of the information contained herein, expert legal advice should be sought.