Trusts - the basics |
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Mary Skellam looks at the basics behind trusts.
Trusts are a complex area of law. The concept is historical and developed over time to counteract the strict laws. Trusts are born out of fairness and they exist alongside the law.
Many people believe that trusts are huge pots of money in Switzerland or the Caribbean. In fact, trusts exist in many aspects of our lives without some of us even knowing. For example, if two people own a property together, there is a trust. They legally own the property on paper (or more correctly, electronically registered at HM Land Registry) and “equitably” they own a share also. Even if it is half each, they each are trustees of their own and the other’s share.
A trust is basically a split of the legal ownership in an asset from the benefit.
Everybody has probably heard the word “equity” particularly in relation to the value of a property after taking away the outstanding mortgage. The equity in any property or asset is what the beneficiary is interested in: it is the value that the beneficiary can receive. The trustees hold the legal ownership of the asset for the benefit of the beneficiaries.
It used to help me to think of trusts as an imaginary idea. A trust cannot be seen and is hard to explain. However, when a trust exists it is extremely strong and overrides legal rules.
Trusts can arise in a large variety of situations, even unintentionally. For example, take the thief who runs off with the Crown Jewels (and for a moment forget the criminal consequences). Those jewels do not belong to the thief and under trust law, when the thief is in possession of the items, he is holding them for the rightful owner. If the Crown Jewels were then sold by the thief, the money would be held by the thief as trustee for the Queen. Why? Let me explain about “Equity’s Darling”.
Because the law of trusts is based on fairness, if some unknowing and genuine person buys something that doesn’t actually belong to the seller, such as the stolen Crown Jewels, the innocent buyer is protected. The innocent purchaser is often known as the “bona fide purchaser for value” or “Equity’s Darling”.
So, if Equity’s Darling is safe, and the owner of the Crown Jewels is protected by trust law, where is their benefit? Our thief now has the money for the jewels so this is now held by the thief on trust for the true owner of the Crown Jewels. However, if the thief hadn’t sold the jewels but had given them away, the principle of Equity’s Darling does not apply and the jewels would be held by the new owner as trustee for the Queen.
However, in a legal world there are two main different types of trust. A “fixed interest” trust where the Settlor (the person who creates the trust) dictates exactly who will benefit under the trust, when and under what circumstances. For example, a Settlor decides that Alice should have the use, benefit and income of Wonderland from the age of 25 for her lifetime, and then the benefit would pass to Poppy. The Settlor has created a fixed interest trust. It is clear exactly what will happen and at what time.
Alternatively there is the discretionary trust. This is where the Settlor names the beneficiaries and decides which assets will make up the trust fund, but the trustees decide who will receive what and when as the trust continues. A discretionary trust is often accompanied by a “letter of wishes” which the Settlor uses to express his intentions. However, the letter is not binding and the trustees cannot follow it blindly. The trustees should use their discretion about who will benefit and review things annually. The beneficiaries of a discretionary trust often have to apply to the trustees and plead their case for a distribution. A discretionary trust is a very flexible arrangement and is favoured by Settlors who may have a large family and want to ensure that the correct people benefit at the right time.
These different types of trust have different tax advantages and disadvantages. Most Settlors feel it is important to weigh up their intentions/wishes against the tax consequences before creating a trust.
June 2012
Disclaimer:
Trusts are a complex area of law. The concept is historical and developed over time to counteract the strict laws. Trusts are born out of fairness and they exist alongside the law.
Many people believe that trusts are huge pots of money in Switzerland or the Caribbean. In fact, trusts exist in many aspects of our lives without some of us even knowing. For example, if two people own a property together, there is a trust. They legally own the property on paper (or more correctly, electronically registered at HM Land Registry) and “equitably” they own a share also. Even if it is half each, they each are trustees of their own and the other’s share.
A trust is basically a split of the legal ownership in an asset from the benefit.
Everybody has probably heard the word “equity” particularly in relation to the value of a property after taking away the outstanding mortgage. The equity in any property or asset is what the beneficiary is interested in: it is the value that the beneficiary can receive. The trustees hold the legal ownership of the asset for the benefit of the beneficiaries.
It used to help me to think of trusts as an imaginary idea. A trust cannot be seen and is hard to explain. However, when a trust exists it is extremely strong and overrides legal rules.
Trusts can arise in a large variety of situations, even unintentionally. For example, take the thief who runs off with the Crown Jewels (and for a moment forget the criminal consequences). Those jewels do not belong to the thief and under trust law, when the thief is in possession of the items, he is holding them for the rightful owner. If the Crown Jewels were then sold by the thief, the money would be held by the thief as trustee for the Queen. Why? Let me explain about “Equity’s Darling”.
Because the law of trusts is based on fairness, if some unknowing and genuine person buys something that doesn’t actually belong to the seller, such as the stolen Crown Jewels, the innocent buyer is protected. The innocent purchaser is often known as the “bona fide purchaser for value” or “Equity’s Darling”.
So, if Equity’s Darling is safe, and the owner of the Crown Jewels is protected by trust law, where is their benefit? Our thief now has the money for the jewels so this is now held by the thief on trust for the true owner of the Crown Jewels. However, if the thief hadn’t sold the jewels but had given them away, the principle of Equity’s Darling does not apply and the jewels would be held by the new owner as trustee for the Queen.
However, in a legal world there are two main different types of trust. A “fixed interest” trust where the Settlor (the person who creates the trust) dictates exactly who will benefit under the trust, when and under what circumstances. For example, a Settlor decides that Alice should have the use, benefit and income of Wonderland from the age of 25 for her lifetime, and then the benefit would pass to Poppy. The Settlor has created a fixed interest trust. It is clear exactly what will happen and at what time.
Alternatively there is the discretionary trust. This is where the Settlor names the beneficiaries and decides which assets will make up the trust fund, but the trustees decide who will receive what and when as the trust continues. A discretionary trust is often accompanied by a “letter of wishes” which the Settlor uses to express his intentions. However, the letter is not binding and the trustees cannot follow it blindly. The trustees should use their discretion about who will benefit and review things annually. The beneficiaries of a discretionary trust often have to apply to the trustees and plead their case for a distribution. A discretionary trust is a very flexible arrangement and is favoured by Settlors who may have a large family and want to ensure that the correct people benefit at the right time.
These different types of trust have different tax advantages and disadvantages. Most Settlors feel it is important to weigh up their intentions/wishes against the tax consequences before creating a trust.
June 2012
Disclaimer: