Understanding Discretionary Trusts and Their Benefits

A Discretionary Trust is where the person creating the trust (‘the Settlor’) transfers Assets (‘the Trust Fund’) into the control of individuals (‘the Trustees’). The Trustees then have control over the Assets on behalf of individuals chosen by the Settlor (‘the Beneficiaries’).

A beneficiary is not automatically entitled to a share of the trust fund and any payment or transfer out of the trust fund is at the discretion of the Trustees. A discretionary trust gives trustees the power to decide how much the beneficiaries get from the trust fund and when they will receive it. Any income generated by the Trust Fund is distributed completely at the Trustees’ discretion or can be accumulated (added) to the main fund. The greater level of flexibility provided by a discretionary trust allows assets to work with and be protected from the changing circumstances of the beneficiaries.

The Settlor of a discretionary trust is best advised to write a detailed letter of guidance for the trustees to help them make decisions in accordance with their intentions. However, any such letter of guidance is not legally binding on the Trustees and the administration and distribution of the Trust Fund is at the complete discretion of the Trustees.

When are Discretionary Trusts Useful?

Discretionary Trusts are particularly useful in several situations:

Protecting Assets for Vulnerable Beneficiaries

Discretionary trusts can be a valuable way of protecting assets that are passing to those who don’t have the ability to manage their funds effectively. There are a number of reasons why the settlor may feel the beneficiary is unable to manage their own funds, but common examples include situations where the beneficiary is a child, is not mentally capable of managing their own money, or suffers from addiction. In these circumstances, a discretionary trust allows the trustees to make payments on behalf of the beneficiary without making distributions from the trust funds directly to them, avoiding potential detriment or misuse of the funds.

Protecting Assets from Third Parties

Discretionary trusts can also be used to keep assets away from third parties who may make claims on a beneficiary’s estate. By placing assets in a discretionary trust, none of the beneficiaries have an absolute claim on the funds held. This provides protection in the event of divorce, bankruptcy proceedings, or claims by business creditors, as the assets in the trust do not belong to the beneficiary.

Preserving Benefits Entitlements

Many individuals want their family and friends to benefit from their assets but are concerned that any payment or inheritance they receive will affect their entitlement to benefits. A discretionary trust allows the beneficiary to access the trust fund at the discretion of the trustees, without affecting their means-tested benefits.

Maximising Inheritance Tax Relief

Discretionary trusts are valuable when considering how to pass on property after the Settlor’s death. Certain inheritance tax benefits, particularly those related to businesses and agricultural land, can be lost when these assets are passed to a spouse and then subsequently to children. A discretionary trust can help maximise these benefits, which might otherwise not be available at the time of the spouse’s death.

Important Considerations

As with any trust, before setting up a discretionary trust it is important to take legal and tax advice from an appropriately qualified professional. Discretionary trusts have several reporting obligations which need to be adhered to including registering the trust with HM Revenue and Customs Trust Registration Service. It is also crucial to choose the right people as Trustees that understand the reasons why the Trust was created, will respect those wishes and manage the fund appropriately.

You can set up a discretionary trust during your lifetime or write it into your Will to come into effect after your death. If you set up a discretionary trust while you’re alive, care will need to be taken regarding the value of the fund being transferred into the Trust. This is because the transfer of the asset into the discretionary trust will be treated as a “chargeable transfer” for inheritance tax purposes. If the total number chargeable transfers exceed the inheritance tax threshold of £325,000 over a seven-year period, then the amount over the threshold will be taxed at 20%.

These are treated differently to lifetime gifts to individuals which are known as “potentially exempt transfers” (“PETs”). PETs only become chargeable transfers if the person who made the gift die within seven years of making the gift.

Some discretionary trusts will enter a special type of tax system known as the ‘Relevant Property Regime’. This means that there can be additional reporting requirements, entry charges, exit charges and ten-year anniversary charges. All of this is dependent on the nature and value of the assets being transferred into the discretionary trust. As such it is vitally important that advice is taken from suitably qualified advisers to provide advice regarding the legal and tax implications for making Trusts of this kind.

How Pinney Talfourd Can Help

If any of the above scenarios relate to you or you feel that you may already be a settlor or beneficiary to a discretionary trust you can speak to an advisor at Pinney Talfourd. Our specialists are experienced in the creation of discretionary trusts either during a person’s lifetime or in their Will. We can assist with the registration, administration or winding up of a discretionary trust and assist and advise in relation to any reporting requirements related to the discretionary trust.