The best way to establish a trust worth believing in

The term "trust" or "settlement" is liable to strike terror into the heart of some readers who associate them with unending legal tangles or other past, unhappy, experiences. An old and inflexible family trust which could not adapt to radically changed personal circumstances may indeed have become a mill-stone.

However, the modern trust should not be like this at all. They have their place in most financial planning and, if properly drafted, can be flexible and very efficient.

What is a trust? Put simply, it allows you to entrust your money (or other assets) to another (the trustee) for safekeeping and management, for the benefit of specified individuals.

A fuller definition is more difficult. The trust is like a Swiss Army penknife - because there are very many different sorts but you would recognise one when you saw it.

In the same way that the penknife can have many uses, depending on what blades are included at the outset and the ingenuity of the designer, so the trust can also be designed at the outset to do one particular job or very many different things and cope with changing situations.

There is a certain amount of jargon that goes with trusts. Some of the key words that you will inevitably come across are:

Settlor - The person who sets up the trust and puts the assets into it.

Trustees - The people with the responsibility to manage the trust.

Beneficiaries - These are the people who may benefit under the trust. Just because a person is a beneficiary does not mean that they will benefit - it just means they can benefit. A lot will depend on the way in which the trust is written.

Trust Deed - This is the document that creates a lifetime trust.

Will Trust - This is simply a trust created under someone's Will.

So what are the uses of a trust? In the context of a family there are usually two reasons why a trust may be appropriate. The first is tax planning as there are a number of ways in which the trust can be used to reduce or eliminate a tax liability. The second use is the prevention of a particular beneficiary from gaining access to large sums of money.

The beneficiaries could be children or grandchildren who are too young to be responsible with the money.

Alternatively, the settlor could be, for example, a husband or wife on a second marriage who makes the trust under their will to ensure that the second spouse will be provided for, but by the same token will also ensure that the assets eventually pass to their own children rather than to the children of the second spouse.

It is necessary to outline some of the basic differences between the types of trusts as these can have important tax consequences. Any of these trusts can be created during someone's lifetime (an inter vivos trust) or on death (a Will trust).

Interest in Possession Trusts benefits one person (although it can be more), who is known as the life tenant and is entitled to the income that is generated by the assets within the trust. In a typical example, you might have a house and Stock Exchange investments which make up the trust's assets.

The life tenant would have the right to live in the house and receive the dividends from the shares. However, the management of the trust's assets (and this would include whether to buy or sell the house) would lie with the trustees.

The trustees would also have power to sell investments and, if appropriate, pay some or all of the proceeds of sale to the life tenant, should he or she need it. On the death of the life tenant the trust document will determine where the trust assets should go.

This type of trust might well be used in the case, mentioned above, of a second marriage where both spouses have children from previous marriages. A will would create an interest in possession trust. The survivor would have that interest in possession and would be entitled to the income. The trustees would be able to decide from time-to-time whether the survivor needed distributions over and above the income they were already receiving.

Discretionary trusts are the most flexible form of trust. The Settlor gives the trustees very wide powers to determine who gets what. The trustees can accumulate income if they do not want to distribute it.

Accumulation and Maintenance trusts are a special kind of discretionary trust for young beneficiaries. On creation, all the beneficiaries must be under the age of 25 and must get (on or before reaching 25) a right to the trust income or to a portion of the trust's assets outright.

This type of trust is very common for children or grandchildren. For example, if grandparents wish to leave money to their young grandchildren, they might well use this type of trust. The trustees would be responsible for the management of the money and would use it for the beneficiaries as and when they need it; for example in paying school fees.

Trusts can be used for all sorts of purposes and changing situations. To extract best use from them and for them to perform the function for which they are intended it is important to seek professional advice. As with the Swiss Army knife, if the right tools are not included at the outset it will be at best inefficient and at worst useless.

Anthony Thompson is a partner of solicitors Lawrence Graham