Common problems with trust forms and how to avoid them
16 October 2018
29 July 2019
Barbara Gardener, Technical Connection
Over the last three months we have been looking at the reasons why the use of trusts, especially with protection policies, is not as popular as it should be.
We have considered whether there might be simpler alternatives to the current process for setting up a trust, including the possibility of setting up trusts electronically, especially in the light of the ongoing Law Commission consultation on the execution of documents electronically. However, all this is in the future. Meanwhile we have to cope with the existing legal requirements and systems for setting up a trust as best we can. Therefore, this month we will look at some common mistakes made when creating trusts and how to avoid them.
A recent case we had to advise on at Technical Connection illustrates some common problems.
The case of a missing trust and an incomplete deed
Mr F created a trust of an investment bond in 2005. The trust was a flexible power of appointment trust. His intention at the time was that his two adult children were to benefit in due course and so he named his son S and daughter D as equal current (default) beneficiaries. The trust included the usual several classes of potential beneficiaries to whom the trustees could make appointments of benefits to override the default position.
In 2017 Mr F died. Under his will, made in 2016, his daughter D was the executrix and the sole beneficiary of his estate.
D made a claim to the life office in respect of the bond, apparently unaware of the existence of the trust. The life office had a record that a trust existed but held no copy of the trust and no record of any additional trustees having been appointed by the settlor.
After some searching, a copy of the trust turned up. This did not include an appointment of additional trustees. D continued with her claim on the grounds that in the absence of a surviving trustee, she was entitled to the proceeds as the executrix. This would have been a proper course to follow except that a deed of appointment of trustees which was executed a day after the trust was subsequently found. In this deed the settlor appointed his wife and both his children D and S as additional trustees. Both the widow and the son are still alive. However, the deed of appointment, while naming the parties and having spaces for all the parties to sign etc, was executed only by the settlor, S and D. His then wife did not sign the deed. The question was therefore whether the deed - and so the appointment - was valid.
Apart from the fact that the documents were not immediately to hand and so the process took months, the problems may not have been as dramatic if all the family members were cooperating. However, it transpired that a few years after the trust had been set up, there was a breakdown in family relationships culminating with the father disinheriting his wife and son. (Hence the new will in favour of the daughter). D was not on speaking terms with her brother.
Correspondence was found dated from 2015 where the settlor requested the adviser (representative of the life office) to provide the necessary forms to change the beneficiaries under the trust but this was never actioned. Even though in writing, this was not enough to effect a change of beneficiary under the trust, which had to be by a deed executed by the trustees.
With regard to the deed of appointment of additional trustees, it was decided on balance that it was valid as far as the appointment of S and D was concerned as it had been executed by F and D and S. However, the widow was not validly appointed. As a result, any payment of the bond proceeds could only be made to both the trustees into a joint bank account, and S and D shared the proceeds between them.
D considered that she had lost half of her entitlement due to negligence of the life office. At this stage we do not know whether she will take this further, but it is a possibility.
Clearly neither D nor the settlor at the time he wanted to change the beneficiaries received proper advice. D appeared not to understand that the trust in question was a flexible trust and so the trustees could still follow the settlor's wishes and appoint the funds to her. Of course, this may not have been possible with only her brother as the second trustee but it may have been a possibility if an independent trustee was appointed, assuming that indeed her father's intentions were clear in this respect. This is, of course, now academic.
The case illustrates how many things can go wrong in what starts as a straightforward gift to a trust. Clearly the adviser was at fault for not having dealt with the settlor's request concerning the change of the beneficiaries. The life office was at fault for not having a proper record of the trust or of the deed of appointment of additional trustees (both of which were only found after a lengthy delay). And, of course, for accepting the deed of appointment given it had not been executed by all the parties.
It is important to use the correct terminology. Trusts are usually created using a trust deed or a trust declaration. In the case of a new life policy trust, a trust can also be set up by means of a "trust request and declaration". Some people refer to any form provided by a life office in connection with trusts as a "trust form". Others use the term "trust form" to denote the actual trust declaration or trust deed.
Confusion in the terminology, coupled with incorrect completion, can lead to disastrous consequences as illustrated in the case Pappadakis v Pappadakis (TLR 19/1/2000) [www.thetimes.co.uk/tto/law/reports]. In this case (dealt with in detail in one of the previous articles), despite the form having been described as a “declaration of trust”, it was decided that no valid trust had been created, although there were no adverse financial consequences as the asset in question passed to the spouse.
However, in the case of Andrews (19 March 2010 (76528/1) [ www.pensions-ombudsman.org.uk/determinations/docs/2010/mar/76528], considered by the Pensions Ombudsman, a life office which provided an incorrect form found itself liable for an inheritance tax bill of £137,000 incurred as a result of the purported trust being declared invalid so that the policy proceeds formed part of the taxable estate..
It is unfortunately, a fact of life that these days providers, whilst offering draft trust documentation, often no longer have in-house technical departments. Instead, the processing of documentation is often outsourced to companies who specialise in the processing of administrative tasks but who generally have little technical or legal expertise. In the past if a trust form had not been completed correctly, any errors would normally be picked up when the application for the life assurance policy or investment was being processed and any potential problems avoided by rectifying any mistakes. These days frequent errors such as incomplete documentation, for example, omitting to specify the asset going into the trust, (e.g. policy number), omitting to name default beneficiaries or beneficiaries entitled to income, lack of signatures etc. might go unnoticed and only come to light in the event of a claim arising. At such point it will generally not be possible to rectify any errors in the document itself and, if the error is substantial, the potential consequences can be disastrous.
While the draft documentation will be provided by the investment or life assurance provider, the onus will be on the adviser, especially if he is remunerated by a fee, to ensure that all the documentation is completed properly and, if that is not the case, he may find himself liable for any consequences. Indeed, this concerns not just the completion of documentation but the entire process of setting up a trust including compliance with the identification requirements for anti-money laundering purposes.
However, the responsibilities of the life offices must not be underestimated. Many life offices have been taken over or merged etc and, in our experience the fact that trust documents or records have been lost somewhere along the line is not unique to the case mentioned above. It is the responsibility of the life office to keep proper records and this applies not just to records of individual clients but also records of the trust documents they have provided in the past. It is not unusual for a client to lose a copy of the trust document while a record of the trust exists. With some trusts having all the variable information on the front page and the trust terms on the last page we have also come across cases where the trustees have copies of the front page but not the last one. It does not help if the life office does not keep a record of the trust wordings which were being offered at the time the particular trust was et up.
The need to name default beneficiaries under a discretionary trust is one of the areas that has led to many misunderstandings and mistakes when completing trust forms and so deserves a special mention. It would appear that for some there is a conflict between the idea of having a discretionary trust and at the same time having to include someone’s name under the trust. There are of course good reasons why default beneficiaries must always be identified.
The first reason is the general principle of trust law that a trust should state who should become entitled to trust property should the other terms of the trust fail, even though such an event is most unlikely. The second reason concerns the tax implications.
If you do not have a properly drafted default clause, you have the possibility of a resulting trust, i.e. the trust property reverting to the settlor. This will not be fatal from an IHT standpoint because of HMRC's confirmation to the Law Society that the gift with reservation of benefit rules will not apply where the benefit to the settlor arises by operation of the law. However, it would, at least in our view, render the trust subject to the pre-owned assets tax (POAT) rules if the value of the trust fund causes the annual deemed rate of return to exceed £5,000. The trust could also be ‘settlor-interested’ for income tax purposes although this would not usually be relevant to trusts of life assurance policies that only pay out on death.
There are various ways of drafting the default beneficiary clause but it is very easy to get things wrong (i.e. draft a clause that may fail). For example, the words "Such of my children as are alive at the time.." would not be satisfactory, as either the settlor may not have any children or none may be alive at the relevant time.
For the above reasons trust draftsmen tend to favour either naming specific individuals or charities as the default beneficiaries. However, this need not be the case. It is possible to draft a default clause that will not require naming anybody but not many offices have so far taken up this option. Given how many headaches this issue causes, perhaps it is time to reconsider the current prevailing approach.
Meanwhile the useful rule for advisers would be: if the completion instructions in a trust require a name to be inserted, please stick to that, i.e. make sure a name or names are inserted and avoid adding any other words: chances are they may just complicate matters or worse still make the clause faulty.
Sometimes the inclusion of named default beneficiaries is also seen by advisers as a way in which a settlor can give an indication as to who they would wish to benefit on death, although this is actually what is likely to lead to misunderstandings. The proper place for the settlor of a discretionary or flexible trust to indicate their wishes is in a separate letter of wishes to the trustees, not the trust deed.
While some mistakes will always happen, most can be avoided by taking appropriate care when completing the documentation. To this end life offices can help by producing clear and unambiguous documents which are easy to complete and which eliminate or at least minimise the scope for error. However, even with an easy to complete form, trust matters should not be rushed through and it is essential that clients (which will include the settlors, trustees and beneficiaries) have a full understanding of what is involved in having a trust. And this part is up to the adviser. As shown above, consequences of getting things wrong can be disastrous and very costly. For the clients, advisers and life offices alike.
This document is believed to be accurate but is not intended as a basis of knowledge upon which advice can be given. Neither the author (personal or corporate), the CII group, local institute or Society, or any of the officers or employees of those organisations accept any responsibility for any loss occasioned to any person acting or refraining from action as a result of the data or opinions included in this material. Opinions expressed are those of the author or authors and not necessarily those of the CII group, local institutes, or Societies.