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Don&#39t aim wide of the mark

Over the last few weeks, we have been looking at certain key aspects of trusts as commonly used with financial services products. So far, we have discussed the importance and, in some cases, the lack of importance of the roles of settlor and trustee, noting the powers and duties of each along with importance considerations for the selection of trustees.

This week, I want to move on to the third and last of the main parties to the trust – the beneficiaries.

When I was one of a group of trainees being put through basic trust training many years ago, a common question asked related to the title to the trust assets held by each of the main parties to a trust. It was stressed many times to us that the beneficiaries, although being the people standing to gain ultimately from the trust, only have a beneficial or equitable title to the trust assets. In other words, they are not able to deal with the trust assets as could any legal owner of such property.

The core training then went on to consider what title to the trust vests in the settlor, if the legal title to the trust property vests in the trustees and the equitable or beneficial title vests in the beneficiaries? The answer, quite simply, is that there is no title. The settlor has no further rights over the trust property.

True, in many instances, some or all of the trust property once belonged to that settlor. However, having transferred the property into the trust, the settlor has no further legal or equitable title to that property unless he appoints himself as one of the trustees or lists himself as an initial or potential beneficiary.

This line of questioning was, of course, designed to stress to us that the transfer of assets by a settlor means he has irrevocably lost control over those assets as the settlor. Contrary to our expectations, there is no further ownership or control of those assets by the settlor unless he appoints himself as a trustee.

This was in direct contradiction to the previously held belief of many of us that, if a settlor changes his mind about the efficacy of the trust for his requirements, he can somehow simply unravel the trust, take the transferred assets back out of it and pretend the whole thing never happened.

Setting up the trust in the first place must be seen as a crucial decision, as is the appointment of trustees, as we have already discussed. But the decision regarding the identity of the initial and potential beneficiaries should also be highlighted as being of critical importance.

Before that excellent core training, I had worked for previous insurance companies. One in particular had advised me that the trust wording should make the list of beneficiaries as wide as possible, so as to give the settlor the widest possible future choice of beneficiaries should he decide that his initial selection was no longer appropriate to his wishes.

Of course, that sub-standard training overlooked the fact that it is not the settlor&#39s choice as to future changes in beneficiaries, as this is within the power only of the trustees. But the dangers of the statement are much deeper.

I noted in a previous article in this series that, although it is commonly believed that the trustees must pay benefits from the trust property to the initial beneficiaries and can only consider the list of potential beneficiaries if the initial beneficiaries are dead or cease to exist (the latter category, for example, including circumstances where “my wife” is noted as an initial beneficiary but the settlor subsequently gets divorced), this is not the case in the vast majority of common trust wordings.

The trustees may select for payment of benefits any one or more people from the list of initial or potential beneficiaries. Thus, any suggestion that a settlor should make the list of potential beneficiaries as wide as possible to give the settlor (or, more precisely, the trustees) great flexibility in future is extremely dangerous.

The settlor must, therefore, give proper thought to the list of both initial and potential beneficiaries.

I came across an example a few years ago which highlights this aspect of trusts. A settlor named his son (his only child from his first marriage) as the only named initial beneficiary. However, the classes of potential beneficiaries included (although he did not realise it at the time) his future stepchildren by a later wife. That wife was the sole remaining trustee after his death and directed all the money from the trust to her own children, bypassing the child of the deceased settlor, clearly acting contrary to his expressed wishes but a legal preference nonetheless.

Moreover, care should be taken with the way in which selected beneficiaries or classes of beneficiaries are named or described. I have been advised that stipulating “my wife” as a beneficiary describes the settlor&#39s wife at the date when benefits become due from the trust whereas “Jane Green” means that Jane will remain a potential beneficiary notwithstanding their possible divorce.

Besides the fundamental importance of this distinction, it has great relevance to possible future financial settlements in divorce proceedings.

If the wording of the nomination of the settlor&#39s spouse as a beneficiary excludes that spouse following the couple&#39s divorce, then, during the financial negotiations in the divorce proceedings, the spouse can seek to claim “compensation” (although it is not strictly speaking called compensation) for the value of the benefit under the trust she has lost the chance of acquiring (Matrimonial Causes Act 1973 section 25(2)(h)).

Thus, even though she may well have been far from certain to receive benefit from the trust even had the couple remained married, the mere fact that she has lost the chance of acquiring the benefit gives rise to a possible claim. If, on the other hand, she remains a potential beneficiary even after the divorce (because she was named and not simply described as “wife”) then no such claim can be considered.

Similarly, “my children” brings into consideration all children not only at the date the trust was established but also future children born to the settlor, whereas naming the children would preclude future children unless they were included in a broader definition of potential beneficiaries.

All these issues have to be considered carefully during the completion of each trust document.

During a semi-educated period of my employment, I tried amateurishly to apply some of these principles by, from time to time, deleting whole chunks of suggested wordings (a bit like Yossarian censoring letters in Catch 22, I now recognise) from the pre-printed list of potential beneficiaries frequently supplied with insurance company trust forms. I was quickly (and fortunately) stopped from changing the whole nature of these trusts from flexible to absolute trusts and would caution other half-knowledgeable advisers to seek professional guidance on the completion of these forms.

Next week, I will conclude these discussions about the parties to a trust by identifying more important issues relating to beneficiaries before summarising the routine and the not-so-routine use of trusts for financial advisers.

Keith Popplewell is managing director of Professional Briefing


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