One discretionary trust or two? This was the question raised by a recent enquiry from a grandmother who wished to leave inheritances to two granddaughters, each of whom presented very different planning considerations.
A discretionary trust can provide valuable protection and flexibility where a beneficiary is vulnerable, financially inexperienced or at risk of pressure from others. However, deciding whether a single trust or separate trusts should be used can be equally important.
One Discretionary Trust or Two: The Background
The client was 78 and intended to leave her estate to each of her two granddaughters.
Her first granddaughter was on the autism spectrum. She did not receive means-tested benefits and was not expected to do so. The client was concerned that she had difficulty understanding and managing money. If she inherited a substantial sum outright, the client feared that it could be spent quickly or that other people might take advantage of her.
The second granddaughter was financially motivated and had already asked how much she would receive. She was also planning to marry, and the client had concerns about her partner. In particular, she did not want the inheritance to become available for division if the marriage later ended.
The two granddaughters did not communicate with each other. The client was concerned that the second granddaughter might pressure or influence the first if their inheritances were held together.
The initial recommendation was to use a discretionary trust. The further question was whether one trust should cover both granddaughters or whether two separate trusts would be more appropriate.
Before deciding whether one discretionary trust or two would be the better solution, it is important to consider the advantages and disadvantages of each approach.
Why Use a Discretionary Trust?
Under a discretionary trust, the beneficiaries do not have an automatic right to receive the trust fund. The trustees instead decide:
- which beneficiaries should benefit;
- when they should benefit;
- how much they should receive; and
- whether assistance should take the form of capital, income or the payment of expenses.
Managing the granddaughter’s inheritance
For the first granddaughter, the trustees could retain control of the capital and make payments according to her needs. For example, they could:
- pay rent directly to a landlord;
- purchase suitable equipment;
- fund education, care or transport; or
- pay for a holiday without transferring a large cash sum to her.
Whilst the first granddaughter had capacity, a discretionary trust may be appropriate where a beneficiary has capacity but is inexperienced with money, susceptible to influence or likely to spend an inheritance quickly. The trust can provide practical financial management without making assumptions about the beneficiary’s legal capacity.
Can a Trust Protect an Inheritance on Divorce?
A discretionary trust may also provide a degree of protection for the second granddaughter. As she would have no fixed entitlement to the trust capital, the trustees could avoid distributing the entire fund outright. They could also consider her circumstances before making any payments.
However, a discretionary trust does not guarantee that the inheritance will be protected in divorce proceedings.
The Family Court considers the parties’ financial resources and the wider circumstances of the case. Depending on how the trust has been established and administered, the court may take account of:
- distributions already made from the trust;
- an established pattern of financial support; or
- the realistic prospect that trust funds will be made available to the beneficiary.
Option One: A Single Discretionary Trust
The first option for the client’s planning would be to create one discretionary trust containing the intended shares for both granddaughters.
The trustees could keep internal records that treat each granddaughter’s intended share as a separate notional fund. A letter of wishes could explain that the client would like each share to be considered separately and used primarily for the relevant granddaughter and, if appropriate, her descendants.
This approach would have several practical advantages:
- only one trust would need to be administered;
- only one Trust Registration Service registration may be required;
- the trustees could maintain one set of accounts and records;
- professional and tax compliance costs may be lower; and
- the trustees would retain flexibility to respond to changing family circumstances.
A letter of wishes is not legally binding. It can, however, provide important guidance on the client’s objectives and how she would like the trustees to exercise their discretion.
The main disadvantage is that a shared trust could become a source of tension. This risk would be particularly relevant as the beneficiaries already have a difficult relationship.
Option Two: Separate Discretionary Trusts
The alternative would be to create a separate discretionary trust for each granddaughter.
This would provide a clearer separation of the funds. Each trust could be administered according to the circumstances and needs of the relevant granddaughter.
Different trustees could also be appointed to each trust if appropriate.
Separate trusts may reduce the opportunity for one granddaughter to interfere with or influence the other.
The main disadvantage is the additional administration. Each trust may require its own:
- Trust Registration Service registration;
- accounts and tax reporting;
- trustee meetings and decisions; and
- records.
Professional costs may therefore be higher.
There is generally no inheritance tax advantage in dividing the inheritance between two will trusts. Discretionary trusts usually fall within the relevant property regime for inheritance tax purposes. This can result in inheritance tax charges on each ten-year anniversary and when property leaves the trust.
Trusts created by the same person at the same time will also be treated as related settlements for relevant inheritance tax calculations. Creating two trusts should not therefore be presented as a way of obtaining two separate nil rate bands.
One Discretionary Trust or Two: Comparing the Options
Both options could achieve the client’s objectives.
A single trust would usually be simpler and less expensive to administer. Independent trustees could maintain clear records showing the share intended for each granddaughter.
In this case, however, the strained relationship between the granddaughters was a significant consideration. The client’s main concern was to prevent pressure, conflict and financial exploitation.
Two separate discretionary trusts therefore provided the clearer practical structure, provided the client accepted the additional administration and potential costs.
Whichever option is chosen, independent and suitably experienced trustees would be particularly important given there is a risk of family pressure or influence.
Conclusion
The main issue here was not tax planning but protecting each granddaughter’s inheritance in the most practical way possible. The client’s concerns centred on protecting vulnerable beneficiaries, avoiding conflict and preventing undue influence.
The question of one discretionary trust or two should therefore be approached by considering the realities of the family situation. A structure that works well for one family may be entirely unsuitable for another. Careful drafting, an appropriate choice of trustees and a detailed letter of wishes remain essential whichever route is chosen.
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This article is provided for general information only and does not constitute legal advice. Any advice, wording or clauses referred to are illustrative and should not be relied upon as precedent without full consideration of the client’s circumstances, the will as a whole, and the law in force at the relevant time.
