What is a discretionary trust?
There are a number of different benefits to the creation of a discretionary trust.
A Discretionary Trust can either be set up within your Will or as a lifetime settlement (the latter of which is not covered here and specialist legal advice should be sought in this respect).
A Discretionary Will trust which is part of what is known as the 'relevant property trust regime' - is the most flexible sort of trust that you can create in your Will. It enables you to allow for a Trust to be set up on your death which will then be managed by the people you appoint to look after and manage the Trust 'your Trustees'.
Within the Discretionary trust you can select a number of specified beneficiaries of the trust either by name in your Will or by a class of people (e.g. your children, your nephews and nieces). The Trustees then have discretion as to how, when and for whose benefit to use some or all of the capital and income in the trust.
You can leave your Trustees guidance in a letter of wishes as to how and when you anticipate you would want them to use the assets but they will not be bound by your requests. That said, if you have chosen your Executors and Trustees carefully, they should follow your wishes.
The discretionary Will trust allows for a great deal of flexibility and you can specify the maximum amount/ value you would want to be placed in the trust on death. Inheritance Tax as well as other taxes are however of extreme significance when setting up such a Trust. Such a trust can have the highest inheritance tax charge attached to it.
Taxation of discretionary trusts
Discretionary trusts that are created by Wills are treated differently when it comes to inheritance tax. They are subject to what is known as the ‘relevant property charging regime’ which means that there is a charge to inheritance tax:
When assets enter the trust (40% charge, subject to available nil rate band).
On every ten-year anniversary of the trust (up to 6% of the value of the trust assets).
Every time assets are taken out of the trust and distributed to beneficiaries (up to 6% of the value of the trust assets).
An exception to this is that there is no inheritance tax charge if assets are distributed to beneficiaries from a discretionary Will trust within two years of your death. Any distributions made within this time are treated as if they were made in your Will. For example, it could be possible for Trustees to create a bereaved minor’s trust (e.g. for your children) out of a discretionary trust and for that trust to have favourable inheritance tax treatment going forward.
Specialist advice should be obtained if changes are proposed following your death.
There can also be a significant administrative burdens on your Trustees who should obtain their own legal, accountancy and financial advice in maintaining and operating the trust. Therefore when you are considering setting up such a Trust in your Will specialist legal advice should always be obtained.