Discretionary trusts are a cornerstone of modern estate planning, offering a variety of benefits that can be tailored to meet the needs of clients. Understanding the strategic advantages of discretionary trusts is essential. This article explores the key benefits of incorporating a discretionary trust into a will, with a focus on flexibility, asset protection, tax planning, and practical considerations.
Flexibility in Provision
One of the most significant advantages of a discretionary trust is the flexibility it affords trustees in managing and distributing assets. Beneficiaries of a discretionary trust do not have fixed entitlements, and the trustees decide:
- Who benefits (from the class of beneficiaries)
- When they benefit
- How much they receive
This flexibility is invaluable in situations where beneficiaries’ circumstances may change over time, such as changes in financial need, health, marital status, or vulnerability. For example, if a beneficiary develops financial difficulties or suffers from addiction, trustees can withhold or adjust distributions accordingly. This adaptability ensures that the testator’s intentions are met, even as family dynamics evolve.
Asset Protection
Discretionary trusts provide robust protection for family wealth against a range of risks.
Assets held in a discretionary trust are generally shielded from the personal creditors of beneficiaries. This is particularly relevant if a beneficiary faces bankruptcy or business failure.
In the event of a beneficiary’s divorce, assets in a discretionary trust are less likely to be included in the matrimonial pot for division, as the beneficiary has no fixed entitlement.
Trustees can withhold distributions from beneficiaries who are financially inexperienced, vulnerable, or at risk of squandering their inheritance.
This protective function is especially important for clients with young children, vulnerable adults, or complex family structures.
Tax Planning
Discretionary trusts offer several tax planning advantages, particularly in the context of inheritance tax.
Assets placed in a discretionary trust on death are subject to the “relevant property regime”. This ensures that the trust fund is outside of the beneficiaries’ estates for inheritance tax purposes. This benefit does however come with some drawbacks as the trust will be subject to periodical inheritance tax charges and exit charges.
There are potential will planning inheritance tax strategies which involve incorporating discretionary trusts. For example, placing Business Property Relief qualifying shares into a discretionary trust can crystallise the relief on the first death and protect the assets from future changes in the company’s status or the beneficiaries’ circumstances.
Whilst a discretionary trust does have potential inheritance tax charges, the benefits gained with careful planning can potentially mitigate or outweigh these.
Confidentiality
Unlike the terms of a will, which become public upon probate, the details of a discretionary trust (including the identity of those benefitted and the nature of distributions) remain private. This confidentiality can be beneficial for those with sensitive family circumstances.
Long-Term Family Planning
Discretionary trusts are an effective tool for multi-generational planning. By keeping assets within a trust structure, wealth can be preserved for future generations, The trustees can also ensure that assets are distributed in accordance with the settlor’s wishes, even as family circumstances change over time.
This is particularly relevant for clients with family businesses, as the trust can facilitate the smooth transition of control and ownership across generations, while protecting the business from external claims.
Drafting Considerations
The drafting of a discretionary trust within a will requires careful attention to several factors, including:
- The class of beneficiaries should be defined widely enough to provide flexibility, but with sufficient clarity to avoid disputes. Trustees could potentially be given powers to add beneficiaries to give even further flexibility.
- Trustees should be given broad powers, including power to accumulate income, advance capital, and appoint assets, as well as the ability to transfer assets to other trusts if circumstances require.
- Default beneficiaries should be included in the event that the trust period ends without the trustees having exercised their discretion.
Limitations
While discretionary trusts offer many benefits, there are potential drawbacks.
The trust’s tax regime can be complex, and trustees have ongoing duties, including tax returns, record-keeping, and compliance with trust law. Professional advice is essential to ensure property administration and compliance.
The use of a discretionary trust may have inheritance tax implications. For example, it could affect the availability of the Transferable Nil Rate Band if used on first death, and Residential Nil Rate Band may not be available, as the trust is not considered a direct descendant for inheritance tax purposes.
Conclusion
Discretionary trusts are a powerful and versatile tool in estate planning. They offer flexibility, asset protection, tax planning opportunities, and confidentiality, making them suitable for a wide range of client circumstances. However, their complexity demands careful drafting and ongoing management.
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