Everything you need to know about Children’s Trusts
All parents and guardians want to make sure they’re putting the best systems in place to support their children – both now and in the future – and financial matters are no exception.
While some may be aware that setting up a Children’s Trust is a wise route to go down, particularly for high-net-worth individuals, it can be hard to know where to begin. Fortunately, help is at hand, as Tatler has sought out leading lawyers to provide a comprehensive overview of the process.
In terms of why one might consider setting up a Children’s Trust, Hayden Bailey, Partner at Boodle Hatfield, explains that ‘families will often want to protect and preserve their wealth for the benefit of future generations’: ‘If money or assets are given to the children outright,’ he notes, ‘there is a risk that the children will not have the skill to manage the wealth properly, or that it will be vulnerable on divorce or bankruptcy.’ Moreover, ‘the children may be young and inexperienced and need some guidance in wealth management, and some families feel that giving funds at too young an age can be a disincentive to hard work and drive to succeed in business.’
Patricia Milner, Partner at Withers LLP, adds that those children could be ‘too young to receive an asset outright, maybe because they’re under 18, or because they’re a young adult and it might not be appropriate for them to receive a significant amount of money at too young an age.’ She states that further incentives to set up a Children’s Trust could be to ‘protect the family’s wealth from a third party,’ such as ‘if there was any chance that someone might become bankrupt’, or it could be to ‘protect family money from a future divorce.’
In terms of how Children’s Trusts work, Bailey explains that ‘the funds or assets are transferred to trustees (i.e. people you trust) who manage the assets, not for themselves, but for the benefit of the children, and potentially grandchildren and beyond, as trusts can last up to 125 years and in some cases extend beyond that.’ Indeed Milner adds that while they’re often set up by a parent, ‘it could be set up by a grandparent… for children and their children, for more than one generation.’
Phyllis Townsend, Senior Associate in the Wealth Management team at the global law firm Baker McKenzie, explains that there are a number of ‘specific types of trust that can be established specifically to benefit children.’ These include ‘bereaved minors trusts and bare trusts,’ or for those with ‘the right tax profile and assets, there is more scope to plan with discretionary trusts, which remain a valuable tool for business and family succession planning.’ With discretionary trusts specifically, Bailey notes that ‘the trustees of the trust, who might be, say, three trusteed individuals or a professional trust company, will look after the trust assets for a group of persons called beneficiaries’: ‘The trust is a “discretionary” trust,’ he explains, ‘because the family instil their trust in trustees who will exercise their discretionary powers to benefit the children (and often grandchildren) in accordance with the family’s wishes, distributing the right amounts and at the right time.’ The ‘discretionary element means that the trustees have a great deal of power and so trustees must be chosen carefully.’ This also, however, ‘allows the trust to provide a managed legacy that preserves wealth for many generations and in accordance with the family’s wishes and values.’
It’s important for those considering setting up a Children’s Trust to know that ‘a trust is normally irrevocable,’ says Bailey: ‘That means there is no going back and once the funds have been transferred they cannot be taken back.’ He adds that ‘for tax and other reasons it is generally also the case that the parents themselves can never benefit from the trust.’ Thus ‘setting up a trust requires a lot of careful thought and the trust deed requires careful drafting so that new trustees can be appointed when necessary or the trust could be exported out of the UK if appropriate.’ Individuals should also be aware that ‘some jurisdictions have different trust laws so that trusts can last for longer periods and can provide greater protection against creditors in some cases.’ And while ‘private trusts are confidential,’ says Bailey, ‘the drive toward global transparency means that trusts are not a way to conceal the true owner of the assets.’ Therefore ‘it is essential that good quality legal and tax advice is taken early on as there are a range of tax rules to consider when establishing a trust and the trust will require ongoing reporting and administration,’ and ‘in some families shares in the family company will be transferred to trust to preserve the company in the family.’
Bailey notes that ‘a trust can be created both in lifetime and on death,’ explaining that ‘many Wills are drafted so that a Children’s Trust is created automatically on death by the Will document.’ Milner adds that Children’s Trusts are sometimes ‘set up to come into play when someone dies,’ for example, if ‘you have a husband and by his first marriage he has three children, then he marries again, under his will he might set up a Trust to give the income to his second wife for her lifetime. But when she dies,’ she explains, ‘the assets then go to his children from his first marriage.’
There are also a number of potential complications involved in setting up a Children’s Trust, with Bailey stressing that it’s ‘important to make sure that the family understands what the trust is for, as the children will likely need to be advised of the trust’s existence’: ‘If the family’s expectations are not carefully managed,’ he says, ‘then the children can view the trust as a way of controlling them and conclude that the trust was actually used because their parents did not trust them at all!’ Milner echoes this sentiment, stating that ‘one really important thing for all trusts is that there should be good communication between the trustees and the beneficiaries… so that if there are particular issues that exist, then everyone knows about them, rather than there not being a good flow of discussion between the two.’ Townsend also highlights the importance of rigorous consideration throughout the process, adding that ‘early planning is important to avoid costly and potentially damaging family and trust litigation.’
Furthermore, Bailey notes that there are ‘some important tax points to be advised on, as there are limits on what can be transferred to trust without an immediate Inheritance Tax charge.’ Townsend elaborates, explaining that it’s ‘important to ensure any trust is complying with increasingly rigorous tax, reporting and transparency requirements. Therefore when establishing a new, or maintaining a current, trust,’ she explains, ‘it is important to review the information disclosable about the trust, including the settlor and beneficiaries, with such details becoming more easily accessible.’
In terms of how complex familial dynamics might affect a Children’s Trust, Bailey notes that ‘the law is developing in this area and there have been a number of cases where illegitimate or adopted children may be able to benefit from old trusts, where that was not necessarily the original intention.’ He adds that ‘provided the trust is explicitly drafted it should be possible to limit who can benefit,’ as Milner explains: ‘If you’ve got a family with children from a first marriage and a second marriage and maybe step children,’ she says, ‘people who set up trusts sometimes just want the assets to be enjoyed by their direct descendants.’ Thus the trust can be ‘set up specifically by reference to named individuals – so Anna, Ben and Charlotte – as opposed to ‘children’, which can have a much wider meaning.’ Bailey adds that ‘trusts can help to safeguard assets from divorce claims provided the trust has been managed properly.’ He notes, however, that ‘the matrimonial courts can sometimes take trust assets into account and so we will often recommend that clients children enter into pre-nuptial agreements as an additional protective measure,’ with Milner adding that trusts therefore need ‘careful thought’ and planning in this instance.
A final consideration to take into account in the current climate is that of the coronavirus pandemic, as Townsend explains. ‘It is important to review the impact of Covid-19 on trusts,’ she says, ‘for example following a devaluation of investments. We recommend taking time to review trust assets and documentation from the perspective of the trustee and beneficiaries and taking professional advice if appropriate.’
This article first appeared in Tatler Magazine on 15 September 2020.