TrustsWillsDiscretionary Trust: An Overview

In this week’s article we will provide an overview of what a discretionary trust is and why you might use one.

Discretionary trusts are one of the most commonly used trusts in wills and may often be an important part of a person’s estate plan.

What is a discretionary trust?

A discretionary trust is a trust where the beneficiaries of that trust do not have any entitlement to the income or capital of the trust. The potential beneficiaries of the trust only have a chance that they may benefit from the trust.

The discretionary trust trustees will have complete discretion over how the beneficiaries will be able to benefit from the trust. They will decide at their discretion which beneficiaries benefit, how they will benefit and when they will benefit.

Why use a discretionary trust?

The main reasons to use a discretionary trust are

Protection

This may be protecting the beneficiaries from themselves, for example due to addiction concerns, or from third party claims on that beneficiary.

Flexibility

This could be flexibility for beneficiaries, such as a beneficiary who lacks financial ability to manage the inheritance themselves. Alternatively it may be flexibility for the testator for example if they may want to amend the distribution of the estate often (but the beneficiaries will remain the same).

How is a discretionary trust taxed?

Discretionary trusts are treated as relevant property trusts for inheritance tax purposes. This will mean that if the trust’s assets are over the nil rate band (currently £325,000) the trust will need to pay certain inheritance tax charges known as anniversary charges and exit charges.

Anniversary charges may be payable on the trust assets on every 10^th anniversary of the testator’s death.

Exit charges may be payable when trust capital leaves the trust or in other circumstances where the trust’s value is lessened.

How these charges are calculated is complex but combined these charges will not exceed 6% of the value of which is above £325,000. If the value of the trust is below the nil rate band, there will be no ongoing inheritance tax charges.

For inheritance tax purposes, the trust assets are seen as owned by the trust rather than by the beneficiaries of the trust.

How long can a discretionary trust last?

The maximum amount of time is 125 years, which is a statutory limitation under the Perpetuities and Accumulations Act 2009. However, A discretionary trust can have an earlier end date due to the way it is drafted, for example having a trust period of less than 125 years, or it may end earlier if all beneficiaries have passed away or all the trust assets distributed.