When parents want to set up a trust for their children to inherit, they do so through a trust fund. There are many benefits to this, such as saving Inheritance Tax (IHT) and having more control over where the estate goes and how it is used.

By setting up a trust fund and placing assets into it, generally speaking, you are removing those assets from your estate. This means that the assets no longer have IHT implications after seven years (as long as you survive those seven years), and the assets are protected from being misused or lost, due to financial mismanagement, divorce or claims from creditors. While a trust reduces your IHT liability, it still allows you to specify how and when beneficiaries receive assets. In fact, this can offer more control than simply distributing your assets immediately after you pass away. For example, many parents choose this option to preserve their children's inheritance until the children reach the age of 18 (or older). Trusts can prevent young or vulnerable beneficiaries from receiving large sums at once, and trustees may also make distributions over time or when specific conditions are met.

There are several advantages to a trust fund in the right circumstances, but there are also many important factors to consider. The process can be complicated, so it is important to consult a solicitor to avoid making mistakes. As a starting point, JMW Solicitors has compiled some of the most serious and common mistakes that parents can fall into when setting up a trust fund, and how you can avoid them by planning and properly protecting assets.

Set up a trust fund

One of the biggest mistakes a parent can make is failing to set up a trust in the first place. A trust fund allows (among other things) IHT mitigation and, without one, this tax can significantly reduce the value of your estate. The value of your estate may be a large part of your child's financial future and it is important to preserve it.

A trust not only mitigates tax implications, but also provides opportunities for you to control how the assets of the trust are used following their distribution. You can set rules to restrict your children from using their inheritance for certain things. For example, you might want them to invest in a house, so you can instruct the trustees (those managing the trust) to support this. Without a fund, you cannot place restrictions on how your estate is used after it is inherited by your children or family members.

Be clear about the goals of the trust

Transferring a large sum of money can bring with it a lot of responsibility. You should establish goals for your trust fund and discuss them closely with your solicitor so that you achieve the result you desire from the process.

You could set the trust up so your children receive finances in intervals, or so they receive it as a bulk transfer when they reach a certain age. Each method requires you to manage taxes differently and to do so you should seek the assistance of professional wills, trusts and estate solicitors, like our Private Wealth team, here at JMW.

Trust funds can be used to help provide university or college financial aid, pay medical bills or for general financial security. It is essential that you consider these factors when undertaking estate and tax planning, because beneficiaries may challenge a trust if they feel it is not being managed fairly. Your trust should be structured in a way that prevents disputes, by issuing clear instructions or distributions that are transparent and justified.

While trustees should document decisions clearly to demonstrate that they have acted in the best interests of the beneficiaries, the trust documents themselves can also clarify a trustee's duties in this respect.

Direct your insurance towards the right parties

The way that life insurance and death in service benefits are set up can have a huge impact from an IHT and protection perspective.

One way you can ensure that your assets are distributed in the most beneficial way for you and your children is to create a trust. This allows you to assign beneficiaries yourself whilst the trust fund is being set up, and secures any insurance payments separately from your estate. The payments on your death are protected from IHT and sheltered from issues such as divorce or bankruptcy, but will still be distributed according to the wishes you laid out in the trust agreement.

Choose the right trustees

Appointing the right individual to facilitate the transfer and management of your trust is essential to the protection offered by a trust. A trustee should be a professional or individual who you trust to have strong management and organisational skills, and who will act in you and your family's best interests.

A good trustee will follow your directions and understand how to manage the trust. Choosing a bad trustee may result in the process taking longer to organise or being more costly. In the case of a discretionary trust, the wrong trustee could have a significant impact, as they are empowered to make choices about when and how to transfer assets.

When choosing a trustee, you should also consider factors such as their health and age, as well as their location for practical purposes and ultimately, whether they will be able to carry out the process when the time comes. Trust funds are typically set up well in advance, so you may want to assess whether that chosen trustee will be alive or available to manage the trust appropriately.

If trustees need to change due to resignation, death or incapacity, you should not delay in appointing replacements. Take steps to clarify the responsibilities of these trustees before you appoint them, to minimise the risk of disputes later on. A way to overcome this is to recommend some replacement trustees, in the event that the appointed trustees cannot continue, and to put them on notice of this ahead of time.   

Review the trust regularly

Once you have a trust established, you should revisit it at least once a year to ensure that it complies with current tax rules and remains suitable to achieve your objectives. You could do this in a family wealth planning meeting, which could be run by you or facilitated by a solicitor. Working with an experienced estate planning solicitor with the right financial acumen can make a big difference to the success of your trust fund setup process.

For example, trust laws and tax regulations in the UK are subject to change, and revisions to Income Tax or Capital Gains Tax rules or tax-free allowance thresholds may impact the financial efficiency of the trust. If your trust is subject to regular reviews, this can be identified and addressed efficiently by restructuring the trust, the assets or the agreement.

Ideally, trustees should manage trust assets in a way that complies with regulations and minimises unnecessary tax liabilities, but the settlor (the person creating the trust) can also support this by reviewing the documentation regularly. The financial circumstances or needs of beneficiaries may also change in a way that requires an adjustment to trust distributions. If family dynamics change (through divorce, marriage, death or arrival of new children) the terms of the trust should also come under scrutiny to make sure you understand the implications.