Definition
A settlor-interested trust lets the settlor, their spouse, civil partner, or minor children benefit, so anti-avoidance rules tax all trust income as the settlor's personal income.
Understanding settlor-interested status is essential before creating any trust, as it fundamentally determines who pays income tax on trust earnings and can eliminate expected tax benefits.
What Does Settlor-Interested Trust Mean?
Under Section 625 of the Income Tax (Trading and Other Income) Act 2005 (ITTOIA 2005), a trust becomes settlor-interested when settled property or derived property may become payable to the settlor, their spouse, or civil partner. This broad test captures even remote possibilities of benefit. Section 629 creates a special rule: trusts benefiting the settlor's children under 18 are automatically settlor-interested, even when parents are completely excluded. These anti-avoidance provisions prevent income shifting while retaining access to benefits.
When a trust is settlor-interested, all income is taxed as if the settlor earned it personally at their marginal rate, regardless of who receives it. David creates a £200,000 discretionary trust for his wife Emma and children, generating £8,000 annual income. Even though Emma receives distributions, David pays income tax on the full £8,000 at his 40% rate (£3,200). The settlor cannot deduct trust management expenses. Section 646 creates concurrent liability—both settlor and trustees may be liable, though the settlor's liability is primary.
Being a trustee alone does not make a trust settlor-interested—only beneficial interest matters. Important exceptions exist. Disabled persons' trusts allow the settlor to benefit without triggering gift with reservation for inheritance tax. Grandparents creating trusts for minor grandchildren avoid settlor-interested status because Section 629 applies only to settlor's own children. For parent-created trusts, a £100 annual exemption applies per child per parent. The rules cease when each child turns 18 or marries.
Common Questions
"If I create a trust for my children, will I have to pay tax on the trust income?"
If your children are under 18 and unmarried, yes—any trust you create is automatically settlor-interested under Section 629 ITTOIA 2005, even if you exclude yourself and your spouse. You pay income tax at your personal rate until each child turns 18 or marries. A £100 annual exemption applies per child per parent.
"Can my spouse benefit from a trust I create without triggering settlor-interested rules?"
No. Under Section 625 ITTOIA 2005, if your spouse or civil partner can benefit "in any circumstances whatsoever," it's settlor-interested and trust income is taxed as yours. The mere possibility of benefit triggers the rules. The only exception is qualifying disabled persons' trusts.
"What's the difference between a settlor-interested trust and a gift with reservation of benefit?"
Settlor-interested trusts affect income tax—you pay tax on trust income. Gift with reservation of benefit affects inheritance tax—assets remain in your estate when you die. Both involve retaining benefit but apply to different taxes. Settlor-interested trusts often involve reservation of benefit, creating both problems.
Common Misconceptions
Myth: If I'm just a trustee of my own trust, not a beneficiary, it's settlor-interested.
Reality: Being a trustee does not make a trust settlor-interested. Trustees hold legal title without beneficial interest. A trust only becomes settlor-interested if you, your spouse, civil partner, or minor children can benefit as beneficiaries. Settlor-interested status comes only from beneficial interest, not the administrative trustee role.
Myth: Settlor-interested trusts have no legitimate use because they don't save tax.
Reality: While settlor-interested trusts don't provide income tax savings, they serve important non-tax purposes: disabled persons' planning, asset protection from creditors, incapacity planning, controlled distribution, and vulnerable beneficiary protection. The settlor accepts the income tax cost for other benefits. Grandparents can use non-settlor-interested trusts for grandchildren, avoiding these rules entirely.
Related Terms
Understanding settlor-interested trusts connects to these related concepts:
- Settlor: The person who creates the trust and whose tax position is affected by settlor-interested status
- Trust: The broader legal structure, with settlor-interested being one specific classification
- Beneficiary: Settlor-interested status depends on whether the settlor, spouse, or children are beneficiaries
- Income Tax: The primary tax consequence—settlor-interested trusts trigger income tax charges on the settlor
- Trust Taxation: Settlor-interested trusts have different tax treatment from standard trust taxation
- Reservation of Benefit: The parallel inheritance tax concept for retaining benefit from gifted assets
Related Articles
- Advanced Trust Planning Strategies: Covers sophisticated structures where understanding settlor-interested rules is essential
- Inheritance Tax Planning with Trusts
- Understanding Trust Taxation in the UK: Contrasts settlor-interested taxation with other trust types
- Income Tax Implications of Estate Planning: Covers how settlor-interested rules affect income tax planning
- Trusts for Children and Grandchildren: Tax Planning: Addresses Section 629 rules for parent versus grandparent trusts
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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.