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Trust Law/Level IV · Trusts that care/4.3 Protective arrangements/Lesson 5

Hybrid trusts

What people mean by a ‘hybrid’ trust, why the word has different meanings in different places, and how the UK tax label ‘mixed trust’ differs.

Education, not legal advice. Trust law changes from country to country and state to state, and the right structure depends on your situation. Anything you sign should be drafted or reviewed by a qualified lawyer where you live.

The lean path

The cheapest, lowest-tax, simplest and most private route the law allows, best first. Each step names the rule it rests on and the condition that keeps it lawful.

  1. Before paying for any ‘hybrid’ product, ask which meaning and which jurisdiction’s law is intended; the label has no single legal definition, and the question costs nothing.
  2. A fixed interest and a discretionary part can sit in one deed instead of two trusts; in the UK HMRC taxes each part of a ‘mixed trust’ under its own rules, so trustees must keep separate records.
  3. For a beneficiary on means-tested benefits, place their share in the discretionary part: a fixed right to income can count for SSI or Medicaid, while a discretionary interest generally does not.
  4. A US hybrid asset-protection trust starts as a third-party trust with the settlor excluded; once a protector adds the settlor, that part is self-settled under UTC §505, and 11 U.S.C. §548(e) reaches fraudulent transfers within 10 years.

MaterialsA copy of the trust document you are reading, if you have one, to see which parts are fixed and which are discretionaryHMRC’s ‘Trusts and taxes: types of trust’ guidance (UK), free on gov.ukLessons 3.2.4 and 4.3.2, on discretionary trusts and on creditors and self-settled trusts

Wonder

  1. Is a ‘hybrid trust’ a legal category, or just a label?
  2. How does a trust with both fixed and discretionary parts work day to day?
  3. What changes if a settlor is later added as a beneficiary of their own trust?

Explore

  1. ‘Hybrid trust’ is not a single legal category. Writers use it for different arrangements, and its meaning depends on the writer and the country. Three uses are common: a trust that mixes fixed and discretionary interests; the UK tax idea of a trust with parts taxed on different bases; and, in US asset-protection planning, a trust for others to which the settlor can be added as a beneficiary later. When a document or adviser calls a trust ‘hybrid’, it helps to ask which meaning is intended and which jurisdiction’s law applies.
  2. The first use is a trust that combines fixed and discretionary interests. For example, one beneficiary may have a right to all the income for life, while the trustees have discretion over capital among several family members. Or one share may be held for a named person outright, while the rest is held on discretionary trust. The fixed part gives its beneficiary a right they can enforce; the discretionary part gives trustees flexibility, but its beneficiaries have no fixed right to anything (lesson 3.2.4).
  3. In the UK, HMRC’s guidance does not use ‘hybrid’ as a category. Its ‘types of trust’ page instead lists ‘mixed trusts’: a combination of more than one type of trust, such as an interest in possession part and a discretionary part. The different parts are treated according to the tax rules that apply to each part. So the tax position of such a trust is worked out piece by piece, and trustees need records that keep the parts separate. Tax rules change, so HMRC’s current guidance is the place to check.
  4. In US asset-protection planning, a ‘hybrid’ trust, sometimes called a hybrid domestic asset protection trust, starts as a third-party trust, typically for a spouse and descendants, and the settlor is not a beneficiary. A trust protector or other independent person has power to add the settlor as a discretionary beneficiary later. It is usually set up in a state that allows self-settled asset protection trusts. Commentators disagree about how much protection it gives, and no source guarantees it will work against a particular creditor.
  5. Adding the settlor changes the analysis. Once the settlor can benefit, the trust is self-settled for that part. Under Uniform Trust Code §505, in states that follow it, a settlor’s creditors can reach the most the trustee could pay to or for the settlor. Only a minority of states allow domestic asset protection trusts, beginning with Alaska and Delaware in 1997 and Nevada in 1999, and federal bankruptcy law (11 U.S.C. §548(e)) can reach some transfers to such trusts made within 10 years (lesson 4.3.2).
  6. Mixing features has trade-offs. A fixed interest is more certain for its beneficiary but may be easier for creditors to reach and may count for means-tested benefits (lesson 4.1.1); a discretionary interest is more flexible but gives no right to payment. Mixed structures can also cost more to run, because trustees must account for each part. Whether any of these designs suits a family depends on its circumstances and local law; this lesson describes the meanings of the word and does not suggest using any of them.

Key facts

  • ‘Hybrid trust’ is not a single legal category; its meaning depends on the writer and the jurisdiction.
  • One common meaning is a trust that combines fixed interests, which beneficiaries can enforce, with discretionary interests decided by the trustees.
  • HMRC’s UK guidance uses the term ‘mixed trusts’, not ‘hybrid’: the different parts are treated according to the tax rules that apply to each part.
  • In US asset-protection usage, a ‘hybrid’ trust starts as a third-party trust, and a protector or other independent person can later add the settlor as a discretionary beneficiary.
  • Once the settlor is added, the trust is self-settled for that part; under UTC §505, a settlor’s creditors can reach what the trustee could pay to the settlor.
  • A fixed interest gives more certainty to its beneficiary; a discretionary interest gives flexibility but no right to payment.

Exercise nine, six, three, one

9CollectList up to 9 features you might find in a trust document (some trusts have fewer), such as a right to income, a share of capital at an age, trustee discretion, a protector’s power, a spendthrift clause or a power to add beneficiaries.
6ClusterSort them into 6 categories: fixed rights to income, fixed rights to capital, trustee discretion, powers held by others such as a protector, protective terms, and features you are unsure about.
3DistillReduce the 6 categories to 3 groups: features that give a beneficiary an enforceable right, features that depend on someone’s discretion or decision, and features you would want explained by a lawyer.
1CrystallizeWrite 1 sentence explaining, in your own words, why the word ‘hybrid’ alone does not tell you how a trust works.

Fact check

Dates, figures and claims checked against the published sources listed below.

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