What is a Discretionary Trust?
A discretionary trust is a trust under which the trustees have a power to use the trust assets for the benefit of any of the named beneficiaries as they see fit. No beneficiary has any right to any of the assets in the trust, they only have a chance that the trustees could benefit them.
As the trustees have complete control over the assets held in Trust, it is advisable that the Testator writes a letter of wishes accompanying the Will to guide the trustees and inform them of any particular concerns. It must be remembered however, that letters of wishes are not legally binding and trustees are not bound to follow them.
The main reasons to use a discretionary trust come under two different arms; protection and flexibility.
This may be protecting the beneficiaries from third parties or protection from themselves.
One of the chosen beneficiaries may, for example, have divorce proceedings pending or be at risk of bankruptcy. Giving to this beneficiary outright could lead to their inheritance being lost through those proceedings.
Alternatively, a beneficiary may be a spendthrift or has drink, drug or gambling problems and the testator may not trust them to inherit a large sum of money.
Rather than giving to that beneficiary outright, the testator could instead gift to a discretionary trust with that person as a potential beneficiary. Whilst their issues are ongoing, the trustees could provide occasional benefits (for example to pay for rehab or towards solicitors’ fees in a divorce). Once the trustees deem it appropriate to do so, they could then pass that beneficiary’s inheritance to them.
It may be the case that a beneficiary is somewhat limited in their financial ability and the testator may be worried about how they would cope with inheriting large sums outright. In such a case, by passing to a discretionary trust instead, the trustees could hold the assets for that beneficiary and manage these assets for them.
Discretionary trusts may be used to hold assets for disabled beneficiaries who may lack the ability to deal with them themselves, or alternatively may need an inheritance drip fed to them to avoid losing benefits. Depending on the beneficiary’s circumstances, a disabled persons trust may be a better option for them.
Some of the beneficiaries may have their own inheritance tax issues that they do not want to worsen. Discretionary trusts are their own legal entity for inheritance tax purposes, so an inheritance could be passed to the trust. The trustees could then provide occasional benefits or loans to that beneficiary rather than receiving their inheritance outright.
Where a testator is likely to want to amend their distributions often, but the beneficiaries are unlikely to change, they could consider passing to a discretionary trust. Rather than rewriting their will every time they wish to change, they could simply amend the distributions in the letter of wishes. The will would however need rewriting to add beneficiaries to the trust.
Other Uses for a Discretionary Trust
Discretionary trusts can be utilised in cases where a Will is urgent, for example deathbed Wills or where a life-threatening operation is to soon take place. It can be the case that a client wishes to avoid Intestacy, but is uncertain on the exact distribution of the estate. A discretionary trust of Residue could therefore be included naming all the potential beneficiaries as they wish and a letter of wishes written to give trustees guidance.
Discretionary trusts require more than one beneficiary to exist. It is not possible to have a discretionary trust for just one person.
A discretionary trust can last up to 125 years. They may be ended earlier however if the trustees distributed all the trust assets to the beneficiaries or if all the beneficiaries have died.
If the value of the discretionary trust is over the NRB, exit charges and 10 year anniversary charges will apply to the trust. Anniversary and Exit Charges will vary depending on a variety of circumstances, such as the value of the trust itself, but both cannot currently exceed 6%. Under S144 Inheritance Tax Act (IHTA) 1985, any distributions out of the discretionary trust after three months but before two years of the Testator’s death are ‘read back’ into the Will and for IHT purposes are seen as if the Will had made that gift. Exit Charges will therefore not apply to any distributions made within this time period.