Settlor-interested trusts: at a glance
What do I need to know? A ‘settlor-interested’ means you or your spouse could benefit from the assets you place into the trust.
What does it mean for me? As the settlor, you’re usually responsible for paying Income Tax on the trust's income, even if you don’t receive any of it.
Why does it matter? You could exclude yourself and your spouse or civil partner as beneficiaries to reduce your tax bill, but this could mean you give up access to that wealth.
Setting up a trust fund is one way to share your wealth with loved ones. Usually, that means giving up your claim to the assets. But a settlor-interested trust works differently – you or your spouse or civil partner can continue to benefit from the assets you place into it.
So, what are the potential advantages and disadvantages of structuring a trust in this way? In this guide, you’ll learn about settlor-interested trusts and their impact on access and tax efficiency.
The roles within a trust
Before you learn what makes settlor-interested trusts unique, it helps to know the three key roles involved in most trusts. These include:
Settlor: the person who funds the trust
Trustee: the manager of the trust
Beneficiary: the recipient(s) of money and assets
What is a settlor-interested trust?
Trusts where you both pay into the trust as the settlor, and list yourself or your spouse or civil partner as a beneficiary.
How do settlor-interested trusts work?
Settlor-interested trusts are unique as you, your spouse, or civil partner can retain a potential benefit from the assets, even though legal ownership passes to the trustees. In most other trust structures, you're excluded from any future benefit.
So, you might choose a settlor-interested trust as a safety net. This trust structure could let you pass wealth to loved ones while maintaining the ability to receive income from the trust yourself, if the trustees agree.
Tax considerations for settlor-interested trusts
Trustees must pay Income Tax on the trust’s income by filling out a Trust and Estate Tax Return. But as the settlor, it’s your responsibility to ensure the bill is paid correctly and declared on your Self Assessment tax return.
There are also circumstances where you may be responsible for paying Income Tax even if you don’t benefit from the assets directly. For example, if your child is a beneficiary and earns more than £100 a year. This applies if they're under 18, unmarried, and not in a civil partnership.
You don’t have to receive anything from the trust for HMRC to treat it as ‘settlor-interested’. Simply the fact that you or your spouse or civil partner could receive income as a named beneficiary is enough.
Like all trust types, settlor-interested trusts come with complicated tax rules. But HMRC places particularly strict rules on settlors when they retain an interest in the trust.
Income Tax
As the settlor, you’re responsible for paying any Income Tax HMRC charges on the trust’s income, even if you don’t benefit from these earnings.
HMRC charges Income Tax at your marginal rate. As an additional rate taxpayer, you’ll pay 39.35% on dividends the trust generates and 45% on all other income.
Inheritance Tax
Inheritance Tax (IHT) rules for trusts are complex.
If you remain a potential beneficiary, HMRC usually treats a settlor-interested trust as a gift with reservation of benefit (GROB). This means HMRC considers the trust's assets to be staying in your estate for IHT purposes, even after you’ve placed them in trust. But this rule generally doesn't apply if you only name your spouse or civil partner as a beneficiary.
Entry, periodic, and exit charges
HMRC also considers direct gifts to fall outside your estate for IHT if you survive seven years. But it treats most trusts as chargeable lifetime transfers with their own tax rules:
Entry charge: HMRC charges 20% IHT on wealth you place into a trust above the £325,000 nil-rate band threshold. This rate applies when the trustees pay the tax. If you pay it yourself, HMRC counts the tax as part of the gift, so the amount due increases.
Periodic charge: trustees pay up to 6% every 10 years on assets above the nil-rate band threshold.
Exit charge: trustees pay up to 6% when moving wealth out of the trust.
What happens to the trust when you pass away?
If you pass away while you’re still a named beneficiary, HMRC treats the assets in the settlor-interested trust as part of your estate for Inheritance Tax under the GROB rules.
The seven-year rule doesn't come into play here, as the reservation of benefit continued until the date you passed away. HMRC then charges IHT up to 40% above the nil-rate band, based on the value of your estate.
This creates two possible Inheritance Tax charges: one when you transferred the gift into the trust, and one charge on your estate when you pass away. HMRC compares the two and only applies the higher charge.
Capital Gains Tax
In general, HMRC charges Capital Gains Tax (CGT) on the profit the trustees make when they sell assets in the trust. But there are circumstances when settlors may need to pay CGT. You should consider speaking with a financial advisor if you’re unsure how much you need to pay.
In most cases, trusts qualify for a £1,500 annual tax-free Capital Gains Tax allowance, which is half of the current £3,000 individual allowance. But if one of the beneficiaries is considered vulnerable, the full £3,000 allowance may apply.
If you've set up more than one trust, HMRC splits this allowance equally between them, down to a minimum of £300 per trust. After this, HMRC charges CGT at 24% on any profits made on asset sales.
HMRC also charges CGT when you transfer assets into the trust that have increased in value since you bought them, based on their market value. Other trust types can sometimes defer this charge with Hold-over Relief, but this relief is unavailable when the trust is settlor-interested.
Advantages of settlor-interested trusts
Despite the tax implications, there are advantages to using settlor-interested trusts:
Transferring ownership: The trustees become the legal owners of the trust's assets, potentially separating this wealth from your personal estate depending on the circumstances. But because you're also a named beneficiary, you keep a beneficial interest in the wealth.
Keeping a safety net: Naming yourself as a beneficiary means you're not excluded from the trust for good. If your circumstances change in the future, you keep the option to benefit from the trust.
Keeping wealth in the family: You can also name your spouse or civil partner as a potential beneficiary. This allows your loved ones to receive payments from the trust during their lifetime.
Disadvantages of settlor-interested trusts
Most of the challenges associated with settlor-interested trusts come from HMRC’s tax rules.
Paying Income Tax: As the settlor, you’re responsible for ensuring Income Tax on any earnings is paid by all trustees, and you may have to pay tax at your marginal rate even if you don’t benefit directly.
Missing out on tax advantages: If you remain a named beneficiary, HMRC usually treats the trust as a gift with reservation of benefit. In this case, HMRC considers the trust’s assets to be part of your estate for Inheritance Tax.
Taking on extra admin: The assets you write into the trust are no longer legally yours, but HMRC can treat them as yours for tax purposes in some circumstances. Trusts can cause administrative headaches, complicating personal tax returns, costing trustee or solicitor fees, and involving compliance requirements.
Is it worth opening or maintaining a settlor-interested trust?
Settlor-interested trusts can provide flexibility in some cases by allowing you or your spouse or civil partner to keep an interest in the trust’s wealth. But the way HMRC taxes settlor-interested trusts means you could take on significant additional responsibilities as a result.
Whether setting up a trust is right for you depends on your personal finances and circumstances. So, it’s important to speak with a financial adviser to get professional guidance before committing your money.
Frequently asked questions about settlor-interested trusts
What is a non-settlor-interested trust?
Non-settlor-interested trusts refer to any trust structure where the settlor explicitly excludes themselves and their spouse or civil partner as beneficiaries of the wealth or assets. One example is a bare trust, in which beneficiaries have an absolute and immediate right to the trust's assets and income, and the settlor has no ability to benefit.
Is a settlor-interested trust a GROB?
If the settlor keeps the ability to benefit, HMRC usually considers the assets in the trusts as gifts with reservation of benefit (GROB). This means HMRC will treat the trust as part of the settlor’s estate when they pass away.
But there are exceptions. If you name your spouse or civil partner as a beneficiary, but not yourself, HMRC may not consider settlor-interested trusts to be a GROB. It’s important to seek qualified financial advice before making significant decisions about how to structure your finances.
Maintaining benefits from your wealth
A settlor-interested trust could provide a helpful way to transfer ownership of the assets you wish to gift. As a named beneficiary as well as a settlor, you can retain some benefit from your wealth. But the rules can be complicated.
Trusts could help you gift some of your wealth on your terms, while keeping the rest of your money accessible and growing elsewhere, like in high-interest savings accounts.
If you’re unsure whether a settlor-interested trust structure is right for your situation and financial goals, consider speaking to a financial adviser.
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