Discretionary trusts are a common feature in estate planning, often set up through Wills to provide for loved ones on an ongoing basis. These trusts give trustees the power and authority to manage and distribute the trust's assets, making decisions about when and how much to distribute, as well as to whom.
What is a discretionary trust?
A discretionary trust is a type of trust where the trustees are granted the power to manage the trust’s assets. They can choose how to invest the funds, whether to reinvest income, and when to distribute money to the beneficiaries.
Unlike other types of trusts, beneficiaries of a discretionary trust do not have an automatic right to the trust’s assets. Instead, distributions are made at the trustees’ discretion, according to the terms set out by the person who established the trust. The trustees can decide when to make payments and how much to give to the beneficiaries each time a payment is made.
A discretionary trust is often set up in a Will but contains provisions that allow it to evolve over time. For example, a trust could be set up to provide money for grandchildren. This enables more beneficiaries to be included as time goes by and more grandchildren are born, making it a flexible tool for long-term planning.
What are the advantages of a discretionary trust?
Potential tax advantages
If a discretionary trust is set up during someone’s lifetime, they may be able to reduce the amount of Inheritance Tax payable by their estate in due course. If the funds are put into a trust at least seven years before their death, the sum held in the trust may not be included in the estate when calculating Inheritance Tax. However, it's essential to seek professional advice when setting up a discretionary trust, as other tax implications might apply, and careful planning is necessary to ensure it is the best option for your circumstances.
2. To provide for a particular class of beneficiary
One key benefit of a discretionary trust is its ability to accommodate future beneficiaries who have not yet been born.
For example, if new grandchildren are born after the trust is established, the trustees can allocate funds to them as needed. If no more grandchildren are born, then the funds can be shared between existing beneficiaries. This makes the situation flexible and relatively easy to administer.
3. To protect the trust funds from being spent unwisely
Some individuals may not have the ability to manage large sums of money or might be easily influenced by third parties. A discretionary trust means that they can be given money when the trustees feel that it will be used wisely, for example, as a deposit for a home, but the bulk of the funds will be protected from unwise spending.
4. To look after funds for younger beneficiaries
If beneficiaries are minors or not yet mature enough to handle a legacy, a trust fund can be used to hold the money until they reach an appropriate age. The trustees can decide to end the trust at this point if they wish, or the trust could be set up to last until the beneficiaries reach a specified milestone.
If an individual has problems, for example, with addiction, then the trustees could decide to hold on to the trust funds and only release money to them for certain purposes.
5. To protect the funds from third parties such as creditors or spouses on divorce
Money in a discretionary trust can often be protected from third parties, such as creditors or divorcing spouses. For example, if a beneficiary is made bankrupt, their trustee in bankruptcy cannot demand money from the trust. If payments are made to a bankrupt individual, however, they will need to be declared to the trustee in bankruptcy and handed over to them. The trustee in bankruptcy can give the bankrupt individual funds for living expenses.
Similarly, money in a discretionary trust cannot usually be accessed by the court when dividing assets in divorce, although the court may take into account income from a discretionary trust when making a financial order.
If a beneficiary is in receipt of means-tested benefits, a lump sum payment from a trust is likely to end these benefits. By putting money into a discretionary trust, the beneficiary’s means-tested benefits should not be affected, as they do not have an automatic right to receive trust funds.
How will the trustees decide when to distribute trust funds?
The person setting up the trust can write a letter of wishes for the trustees. This letter serves as a guide, outlining how and when the settlor would prefer the trust’s funds to be distributed. Trustees will not be bound by this, as the trust must retain flexibility and beneficiaries’ circumstances may change but they are generally expected to take these wishes into consideration when making their decisions.
Discretionary trusts offer a powerful and flexible tool for estate planning, allowing for careful management of assets and tailored support for beneficiaries. Whether you’re seeking to protect assets, provide for future generations, or minimise tax liabilities, a discretionary trust can be an effective way to achieve your estate planning goals.
Contact us
If you or a friend/family member are looking to prepare a Will and would like to make an appointment to see one of our lawyers, please contact our enquiries team by email at privateclient@baker-law.co.uk or telephone 01252 733 770 and ask to speak to the Private Client team about Wills. We will be happy to provide details of our fees and procedure and arrange an appointment to meet to take instructions.
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