Client Guide: Use of Discretionary Trusts

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The problem

For various reasons it may not be desirable to leave assets directly to a beneficiary on your death.  For example:

  • The beneficiary is bankrupt or in danger of becoming bankrupt.  The risk is that a gift from your estate might be paid directly to the beneficiary’s creditors and not benefit the beneficiary personally
  • The beneficiary is going through a divorce.  The danger here is that assets from your estate might pass to a former spouse of the beneficiary
  • The beneficiary is disabled in some way and needs help in managing the money.  If the beneficiary receives state benefits then any money from your estate may merely reduce the entitlement to state benefits and not be of any extra benefit to the beneficiary
  • The beneficiary is a member of a religious cult and any money from your estate might pass directly to that cult

The solution – a discretionary trust

A discretionary trust is a flexible way of providing for a group of beneficiaries which often includes the surviving spouse or civil partner and other members of the family.

A discretionary trust differs from some other types of trust in that no beneficiary is entitled as of right to the trust property.  The trustees choose which of the beneficiaries are to benefit from the trust and in what manner.  The trustees look at all the circumstances both financial and personal of the beneficiaries and decide how they would benefit most from your Will.  For example, it might be more beneficial to pay rent or living expenses direct rather than to give the money to the beneficiary.  Items such as a car or household goods might also be purchased direct.

Usually, we advise clients who are setting up a discretionary trust to leave an informal letter addressed to the trustees to explain why the discretionary trust was set up and to provide guidance as to how the trustees should use their powers.

You choose the terms of the trust

A discretionary trust is entirely flexible and it is up to you to provide in your Will how you would like it to operate.  For example:

  • Trustees - you can choose whoever you wish to be your trustees, for example, your spouse or civil partner and/or one or more of your children and/or your solicitor
  • Beneficiaries - you can select the beneficiaries but they would normally include your spouse or civil partner, your children, grandchildren and perhaps their spouses, widows and widowers
  • Your trustees will choose which of the beneficiaries should benefit from the trust.  They will consider the different needs of the beneficiaries and all the circumstances, including any preference expressed by you in the informal letter you have written to them
  • Your trustees can decide how beneficiaries should benefit from the trust. For instance, they might make only income available to certain beneficiaries
  • Your trustees can decide at what age beneficiaries should receive assets from the trust. For example, if a particular child or grandchild were thought too young to deal with the money responsibly, payment might be delayed
  • If a beneficiary is about to become bankrupt or is going through a divorce settlement then money can be withheld to avoid it being diverted. Similarly, beneficiaries receiving state benefits will not be affected by any potential interest they may have in trust property
  • Benefit for spouse or civil partner - if your spouse is in need of all of the money from the trust then this can be made available without tax advantages being lost
  • Inheritance tax - potentially there is a charge to inheritance tax when capital is paid out of the trust to a beneficiary.  However, only if the value of the trust fund exceeds the nil rate band for IHT (£325,000 in 2014/2015) will tax be payable
  • Other taxes - for income tax the trust will pay a higher rate (45% for 2014/2015 on income over £1,000) but some beneficiaries will be able to reclaim the tax paid. For capital gains tax the trust will pay 28%
  • The trust can last as long as is necessary (often quite a short period) but no longer than 80 years (or 125 years if the Will in which the trust was set up is dated after 6 April 2010).  It ends when all the assets of the trust have been distributed to the beneficiaries
  • If the trust has been set up to guard against some specific risk or cater for a particular set of circumstances, the trustees can bring the trust to an end when its purpose has been achieved, even though this may be well within the maximum period of 80 years or 125 years.

There will be some costs incurred each year in administering the trust as the trustees will have certain tasks to perform, e.g. completing an annual tax return and reviewing investments.

For further information please contact: