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Reserved Powers Trust

Also known as: Retained Powers Trust

Definition

A reserved powers trust is a trust where the settlor retains specific control powers (such as directing investments or appointing trustees) rather than transferring complete authority to trustees—primarily used in offshore jurisdictions with protective legislation.

Understanding reserved powers trusts is essential when evaluating offshore estate planning proposals, as these structures carry significant legal and tax risks in the UK that offshore advisors may not fully disclose.

What Does Reserved Powers Trust Mean?

In a traditional discretionary trust, the settlor transfers legal ownership of assets to trustees and relinquishes control entirely—trustees then manage investments, make distributions to beneficiaries, and exercise all powers independently. A reserved powers trust reverses this approach: the settlor explicitly retains specific powers over trust administration and assets while transferring legal ownership to trustees. These reserved powers typically include directing investments, appointing or removing trustees, amending trust terms, controlling distributions, or even revoking the trust entirely.

The legal framework varies dramatically by jurisdiction. Offshore jurisdictions like Jersey (Trusts Law 1984), Guernsey (Trusts Law 2007), Cayman Islands, and BVI have enacted specific legislation explicitly permitting settlors to reserve extensive powers without invalidating the trust. These statutes list permissible reserved powers and provide statutory "safe harbors" protecting trust validity. By contrast, England and Wales have no equivalent statutory framework—UK reserved powers trusts rely solely on common law principles from the Recognition of Trusts Act 1987, which merely acknowledges that "the reservation by the settlor of certain rights and powers...are not necessarily inconsistent with the existence of a trust" without providing detailed guidance or protection.

The critical legal risk emerged clearly in Webb v Webb [2020] UKPC 22, where the Privy Council established that when reserved powers are so extensive that "the bundle of rights which [the settlor] retained is indistinguishable from ownership," no valid trust exists—the settlor never truly alienated the property. David creates a Jersey trust holding £5 million in business assets, reserving powers to direct investments and appoint trustees while trustees control distributions to his children. Jersey law explicitly permits these reserved powers, making the trust valid. Sarah creates a UK trust with £800,000 but reserves powers to revoke the trust, direct all investments, appoint herself as beneficiary, and control distributions. Following Webb v Webb principles, courts could find she retained effective ownership—the trust is invalid, assets remain in her personal estate available to creditors, and all asset protection benefits vanish.

Reserved powers trusts create substantial tax complications for UK residents. If the settlor reserves power to benefit from the trust (or appoint themselves as beneficiary), HMRC automatically treats this as a settlor-interested trust—all trust income and gains are taxed on the settlor personally under Income Tax Act 2007 provisions, even if the settlor receives nothing. Additionally, the Inheritance Tax Act 1986 "gifts with reservation of benefit" rules frequently catch reserved powers trusts, treating the assets as remaining in the settlor's estate for IHT purposes, destroying potential inheritance tax savings. Offshore trust providers often minimize these UK tax consequences when marketing reserved powers trusts to UK residents.

Common Questions

"What is the difference between a reserved powers trust and a standard discretionary trust?" In a standard discretionary trust, the settlor transfers control entirely to trustees who manage the assets independently. In a reserved powers trust, the settlor retains specific powers (such as directing investments or appointing trustees) while maintaining the trust's validity. This offers more control but requires careful structuring to avoid invalidating the trust under UK common law.

"Can I use a reserved powers trust for UK estate planning?" Reserved powers trusts are primarily used in offshore jurisdictions (Jersey, Guernsey, Cayman Islands) that have specific legislation protecting them. UK law (England and Wales) lacks this statutory framework, making such trusts more vulnerable to being challenged as 'shams' if the settlor retains excessive control. UK-based settlors must be particularly cautious about how much control they retain.

"What happens if I reserve too many powers in a trust?" If you retain excessive control, courts may find the trust invalid, as demonstrated in Webb v Webb (2020). The court ruled that when reserved powers are so extensive that the settlor effectively retains ownership, no valid trust exists. This can destroy asset protection benefits and create tax problems, as the assets may be treated as remaining part of your personal estate.

Common Misconceptions

Myth: Reserved powers trusts work the same way in the UK as they do offshore

Reality: Offshore jurisdictions like Jersey and Guernsey have specific legislation explicitly permitting settlors to reserve extensive powers without invalidating the trust. England and Wales have no equivalent statutory protection—UK reserved powers trusts rely only on common law principles, making them far more vulnerable to being struck down as shams if the reserved powers are extensive. Offshore trust providers market reserved powers trusts heavily, and UK residents working with offshore advisors often don't realize the structural legal differences between jurisdictions.

Myth: Reserving powers over investments is safe—it's only reserving powers over distributions that causes problems

Reality: The Webb v Webb decision makes clear that courts examine the totality of reserved powers, not individual powers in isolation. While reserving investment powers alone may be less risky than reserving distribution powers, the court assesses whether "the bundle of rights retained is indistinguishable from ownership." Multiple individually-innocuous reserved powers can combine to invalidate the trust—there's no simple categorization of "safe" versus "dangerous" powers.

  • Settlor: The person who creates a reserved powers trust and retains specified powers over it—understanding the settlor role is foundational to understanding reserved powers trusts and the risks faced if the trust is invalidated.
  • Trust: Reserved powers trust is a specific type of trust structure where the settlor's retained powers constrain trustee authority—readers should understand basic trust concepts before learning about this variation.
  • Trustee: Trustees in reserved powers trusts have limited authority compared to traditional discretionary trusts—the settlor's reserved powers constrain their discretion, though they must retain the "irreducible core" of trustee obligations.
  • Trust Powers: Reserved powers are a subset of trust powers—specific powers that would normally vest in trustees but are instead retained by the settlor or granted to a protector.
  • Settlor-Interested Trust: Reserved powers trusts where the settlor reserves power to benefit are automatically settlor-interested trusts for tax purposes, triggering HMRC anti-avoidance rules that tax income and gains on the settlor.
  • Reservation of Benefit: The Inheritance Tax Act 1986 "gifts with reservation of benefit" rules catch reserved powers trusts where the settlor retains ability to benefit—assets remain in the settlor's estate for IHT, destroying potential tax savings.

Need Help with Your Will?

While reserved powers trusts represent complex offshore structures with significant legal risks in the UK, most people achieve their estate planning goals with straightforward UK trust options that avoid these complications entirely.

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Legal Disclaimer:

This article provides general information only and does not constitute legal or financial advice. WUHLD is not a law firm and does not provide legal advice. Laws and guidance change and their application depends on your circumstances. For advice about your situation, consult a qualified solicitor or regulated professional. Unless stated otherwise, information relates to England and Wales.