A discretionary trust allows the trustees to decide how and when to distribute the funds to the beneficiaries. This article will cover what a discretionary trust is, its features, benefits, drawbacks, tax implications and more.
Key Points of a Discretionary Trust
- A discretionary trust gives flexible asset distribution, where trustees, through their discretionary powers, can manage the funds based on the beneficiaries’ needs without the beneficiaries having a direct legal claim to the assets.
- Discretionary trusts are great for asset protection and estate planning, protecting assets from creditors and legal claims and avoiding probate for distribution.
- Discretionary trusts are complex and requires careful planning especially on tax implications, so professional advice is needed to ensure compliance and management.
What is a Discretionary Trust?
A discretionary trust is a powerful financial tool that protects the trust fund and benefits selected individuals. Unlike other trusts, the trustees have full discretion over the distribution of funds, providing greater power to trustees to determine the timing and amount of funds distributed to beneficiaries.
One of the best features of a discretionary trust is its flexibility. Trustees can decide on the timing and amount of distribution based on their judgment and the beneficiaries’ changing needs, better asset management and fund allocation.
Beneficiaries don’t automatically have rights to the income or capital in a discretionary trust. Although beneficial ownership is with them, they don’t have direct control over the distribution. This setup emphasizes the trustees’ control, so the funds are used wisely and responsibly.
Features of a Discretionary Trust
A key feature of discretionary trusts is the flexible distribution. Trustees can allocate assets based on the beneficiaries’ changing needs, they can decide the amount and timing of distribution for tailored financial support.
Additionally, trustees have the ability to accumulate income by withholding distributions and retaining the income generated within the trust, offering flexibility in managing the trust’s financial benefits while considering tax implications.
Asset protection is another feature. Discretionary trusts protects assets from creditors or divorce settlements, protects the beneficiaries’ interest and allows them to pass the assets efficiently. This makes them great for shielding wealth from legal challenges and preserving for the future generations.
Benefits of a Discretionary Trust
Setting up a discretionary trust has many benefits especially on asset protection. By keeping assets away from business creditors or a divorcing spouse, these trusts ensures wealth stays intact and used for its intended purpose. This is especially useful for estate planning, from unnecessary depletion of assets.
Another benefit is the ability to set rules for the fund usage. Discretionary trusts allows for specific criteria for distribution, so funds are given to beneficiaries according to their needs. This is especially helpful for families and individuals who can’t manage their own funds.
Also, assets in a discretionary trust are not part of the estate, so no probate. This speeds up the distribution and reduces legal and administrative costs. Setting up a discretionary trust ensures the beneficiaries get their inheritance on time and efficiently.
Disadvantages of a Discretionary Trust
While discretionary trusts has many benefits, it also has drawbacks. One major concern is the lack of control the beneficiaries have over the distribution. Since the trustees have full discretion, the beneficiaries may not get what the settlor intended, resulting to disputes and dissatisfaction.
Another disadvantage is the complexity of setting up a discretionary trust. The process requires thorough planning and legal knowledge, which can be overwhelming for those not familiar with trust law. Also, there’s a risk that the trustees will use the trust for their own benefit, so it’s important to choose trustworthy and impartial trustees.
Discretionary trusts is subject to a more complex tax regime than other types of trusts, so there may be higher tax obligations for the trustees and beneficiaries. Professional advice is necessary to navigate these complexities and ensure tax efficient trust operation.
Tax of a Discretionary Trust
Discretionary trusts has many tax implications, including inheritance tax, income tax and capital gains tax, each with big financial impact. Trustees are required to complete annual accounts and tax returns, indicating the potential complexities and costs involved in managing the trust on an ongoing basis. Professional advisors are necessary to ensure discretionary trusts are tax efficient and comply with the legal requirements.
Inheritance tax implications is especially important. Discretionary trusts can incur several tax charges, entry charge upon creation, periodic charge every 10 years and exit charge for distribution. Gifts to discretionary trusts are chargeable lifetime transfers and may be subject to inheritance tax if it exceeds the settlor’s nil rate band.
Trustees will pay income tax on the trust income at trust rates. For discretionary trusts with total income over £500, the tax rates are very high, 45% for all sources or 39.35% for dividends.
Capital gains tax is another consideration, with annual exemption and specific rates for property and other assets.
Inheritance Tax
Inheritance tax planning (IHT) is a big consideration for discretionary trusts. Agricultural relief can reduce the value of eligible assets transferred into a trust, thereby potentially lowering the IHT liability on such transfers.
These trusts can incur several tax charges, entry charge upon creation, periodic charge every 10 years and exit charge for distribution. Gifts to discretionary trusts are chargeable lifetime transfers and may be subject to help with inheritance tax if it exceeds the settlor’s nil rate band.
Discretionary trusts is subject to IHT relevant property regime, chargeable transfers and periodic assessments. The maximum IHT rate every 10 years is 6% and no exit charge if the distribution is made within 3 months of the 10th anniversary. Working with professional advisors can help with inheritance tax.
Income Tax
Trustees of discretionary trusts will pay income tax on the trust income at trust rates. Income distributed to beneficiaries comes with a tax credit, and trustees are responsible for the payment of tax on the total income of a trust. Trusts with total income below £500 will not pay any income tax, but those with income above this threshold will pay significantly higher tax. From 2024-25, the income threshold below which a discretionary trust’s income will be written down to zero for tax purposes is £500.
Income above £500 will be taxed at 45% for all sources or 39.35% for dividends. Trustees do not have dividend and personal savings allowances for the trust income so proper planning and management of the trust income is necessary.
Capital Gains Tax
Capital gains tax planning (CGT) is another consideration for discretionary trusts. The annual exemption for CGT for discretionary trusts is currently £1,500. CGT rates for discretionary trusts on property is 20% or 24% for non-residential property (20% or 28% for 2023/24).
Trustees can elect to hold over CGT on transferred assets, delaying the tax until those assets are sold or transferred to a beneficiary. Under certain circumstances, CGT on distributions from discretionary trusts can be deferred and trustees can claim Principal Private Residence (PPR) relief when disposing of residential property.
Who can be a Trustee?
Anyone can be appointed as a trustee of a discretionary trust but they must be trustworthy and financially astute to manage the trust. Trustees have more powers than other trustees to decide on distributions from the trust and can deny benefits to beneficiaries based on their discretion.
To avoid conflict of interest, at least one trustee should be someone who has no interest in the trust. This ensures that trustees act impartially and in the best interest of the beneficiaries and the trust.
Who can be a Beneficiary?
Beneficiaries of a discretionary trust can be anyone, even unborn individuals. They can be specific individuals or classes such as children and grandchildren, giving flexibility in estate planning. Beneficiaries can also be future descendants and vulnerable family members who need financial support.
Assets in a discretionary trust are outside the beneficiaries’ estates so assets are protected and used as intended.
Creating a Discretionary Trust
To set up a discretionary trust, it can be established during a person’s lifetime or through a Will to take effect after death. The settlor will typically draft a letter of wishes to guide the trustees in making decisions. This letter is a critical document which outlines the settlor’s wishes and provides a framework for the trustees to follow.
Trustees hold the legal ownership of the trust assets and are responsible for managing them in accordance with the trust deed. They can decide the amount and timing of distributions to beneficiaries, giving a high degree of flexibility and adaptability. This is particularly useful for estate planning so trustees can respond to changing circumstances and beneficiaries’ needs.
But trusts can be complex for lay trustees to understand the trust and tax laws. Professional advisors offer full service for all aspects of trust administration and estate planning so the trust is managed properly and in compliance with the law.
Common Uses for Discretionary Trusts
Discretionary trusts are used to protect assets from being depleted by beneficiaries who may not have financial management skills or be influenced by unsuitable factors such as addictions. Trust help with inheritance is crucial as these trusts manage inheritance tax and facilitate the transfer of wealth and property to beneficiaries, providing tax efficiency and strategic advantages in estate planning. These trusts protect the assets so they are used in the best interest of the beneficiaries.
They also protect assets from business creditors or during divorce proceedings, so additional protection for the settlor’s wealth. Discretionary trusts are useful for estate planning to preserve the beneficiaries’ inheritance from external threats. Settlor interested trusts can also be part of this process.
Also discretionary trusts can maintain eligibility for government benefits for people with disabilities so support is available without jeopardising the financial assistance. These trusts can have beneficiaries from various classes such as future generations and unborn children so flexible and adaptable estate planning.
How We Can Help
Professional advisors such as ourselves at dns can help you setting up trusts. Financial advisers play a crucial role in managing trusts alongside other professionals such as solicitors and tax specialists. They have the experience and knowledge to make sure the trust is tax efficient and in compliance with the law. Advisors work with international and high net worth clients so have solutions for specific needs.
A letter of guidance is often recommended to help the trustees make decisions in line with the settlor’s wishes. Keeping good records of trust additions and investments is important for trust management.
Professional financial advisors also help with inheritance tax so ten year charges and exit fees are managed properly. Call us on 03300 575 902 for Trust Registration Services
Conclusion
Discretionary trusts are a flexible and powerful way to manage and protect assets so beneficiaries get support in line with their changing needs. By giving more power to the trustees these trusts offer a tailored approach to distribution of funds, protection of assets from creditors and other threats.
Whether you want to protect your wealth from legal challenges, provide for vulnerable family members or estate planning, discretionary trusts are a valuable tool. With professional advisors you can navigate the trust administration and tax implications so your trust runs smoothly and efficiently. Read the benefits and drawbacks in this blog and start securing your legacy today with a discretionary trust.
FAQs – Discretionary Trust
What is a discretionary trust?
A discretionary trust gives flexibility by allowing the trustees to decide when and how much to distribute to the beneficiaries. This structure means funds are managed according to the beneficiaries’ needs and circumstances.
Who can be a trustee of a discretionary trust?
A trustee of a discretionary trust can be anyone deemed trustworthy and financially literate. It’s important the appointed person has the necessary skills to manage the trust properly.
What are the tax implications?
Discretionary trusts have tax implications, inheritance tax, income tax and capital gains tax. You need to understand these to comply and plan properly.
Who can be a beneficiary of a discretionary trust?
A discretionary trust can have beneficiaries from various classes, individuals, unborn children and vulnerable family members. This flexibility allows the trustee to distribute benefits according to the needs and circumstances of the beneficiaries.
How can we help?
We can set up and manage discretionary trusts so they comply with the law and are tax efficient. Our expertise prevents problems and makes the trust work for the beneficiaries.
