Discretionary Trusts - What are they and how do they work?

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A Discretionary Trust is when your assets are left in a type of trust that means whoever you appoint as Trustee/s will have the discretion to decide who benefits from the trust and when/how. 

This is the most flexible type of trust you can include in your Will, and is particularly useful if you are not exactly sure how you want to distribute your estate yet, or if your decisions could be influenced by circumstances you aren’t sure of when you make your Will (e.g. the marriage of your child). 

An advantage of this type of trust is that you can name a group as the potential beneficiaries, such as your grandchildren, which would then include future grandchildren who may not have even been born yet. 

Whilst you can name potential beneficiaries for the trust, you pass the ultimate decision to your trustees, who will decide who will become beneficiaries and how to share the estate. 

Who can be a Beneficiary?

  • Named people (e.g. my friend Mary Jones)
  • Classes of people (such as my grandchildren) 
  • Descendants of your children/grandchildren
  • A Charity/charities 
  • Other organisations, such as a sports club

Can a Trustee also be a Beneficiary? 

Yes - although you would need to have at least one trustee that is not a beneficiary. 

It would be important to ensure there is no conflict of interest between their role as trustee, and as beneficiary. 

Are Discretionary Trusts a good idea? What is the purpose of a Discretionary Trust?

Leaving your assets in a discretionary trust could be useful to you for the following reasons: 

  • If one of your children struggles to manage their own finances, you may be hesitant to leave them a significant sum of money. A discretionary trust would allow your trustees to look after the money for their benefit, and to essentially defer payment of the assets until they feel it is appropriate. 
  • If one of your children is not old enough or does not have the mental capacity to manage their own finances
  • If your beneficiary/ies are in receipt of means tested benefits, which they would lose if they inherited a lump sum of money
  • If your beneficiary is in a relationship or married to someone that you feel would influence control over any inheritance if they received it in a lump sum
  • To protect your beneficiary from possible divorce, as if they held the money in their estate as a lump sum, their ex-spouse could be entitled to a share of it. This is also known as a bloodline trust, as assets are able to be kept away from the divorcing spouse. 
  • If your beneficiary has an addiction or mental illness, and you feel they may waste their inheritance if they receive it all at once 

As you can see, a discretionary trust can be useful, particularly if the above circumstances apply to you, and you would like your trustees to have total control over the inheritance. 

You may simply wish to retain some control over your estate for your beneficiary/ies, to give you peace of mind that your assets will not be squandered. 

What about Inheritance Tax (IHT)? 

Trusts in wills are more commonly used to avoid paying inheritance tax

As you will be leaving assets or money to beneficiaries indirectly, this can help you pay less tax on the value of your assets. 

However, having a discretionary trust won’t mean your family won’t have any inheritance tax to pay; there could still be tax to pay if the value of your estate is over the nil rate band of £325,000.

Discretionary Trusts in a Will are subject to anniversary and exit charges, if payments are not made within 2 years from your death. 

There are, however, exemptions available such as Capital Tax exemption. 

Contact us today to speak to an IHT specialist, who can discuss your own personal circumstances and IHT liability with you. 

Who can be my Trustee? 

As the Trustees have complete discretion over the Trust, it is important to appoint someone that you trust to carry out your wishes. 

If you do not feel comfortable appointing a friend or family member as the Trustee, you could appoint us to act as your Trustee for you. 

Appointing a professional as a Trustee would give you further peace of mind, that your wishes will be considered. 

How can I make my wishes known to my Trustee? 

It is advisable to leave a Letter of Wishes, along with your Will. 

This is a letter in which you can give guidance to your Trustees, such as when and in what circumstances your beneficiary is to receive payments. 

A Letter of Wishes is not legally binding, but your Trustees can take the letter into consideration as to what your wishes were in creating the Trust. 

An example could be that you wish for your grandchildren to receive their share of the trust on their 21st birthday, as long as they are capable of handling their financial affairs, or have completed their education. The Trustees could then pay the rest of your grandchildren, but could withhold the money from one or more grandchildren until they attained financial maturity, giving you peace of mind that their inheritance will not be squandered. 

Who owns the assets in a Discretionary Trust?

As explained above, the beneficiary only has a potential interest in the estate. This means that they never actually own the estate, which can help for the purposes of divorce, to keep the money away from any creditors, and to protect your beneficiary’s means-tested benefits. 

What if I change my mind - Can you take money out of a Discretionary Trust? 

Yes- as the Trust only comes into effect on your death, all you would need to do if you changed your mind at a later date, is to make a new Will. 

Can the Discretionary Trust be challenged? 

A Beneficiary cannot challenge the Trustees decision simply because it is unfair; however they can hold the Trustees to account if they have breached their duties. 

A Letter of Wishes would assist your Trustees, in proving that they are carrying out your wishes. 

How to set up a Discretionary Trust in the UK? 

A discretionary trust is a complex legal document, so it is important to get help from a professional to set one up in your Will. 

Contact us at Wills.Services today, for free specialist advice on discretionary trusts.

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