What are Discretionary Trusts?
Wills are often used to set up discretionary trusts to provide for loved ones on an ongoing basis. We look at what Discretionary Trusts are and explain their uses.
A discretionary trust gives power to the trustees to decide how and when trust funds are distributed and to whom. There can be several advantages to a discretionary trust and they are a popular choice in estate planning.
What is a discretionary trust?
A discretionary trust gives the trustees the right to invest money where they see fit and to decide whether to reinvest income or pass it on to the beneficiaries.
The trustees can also decide when to make payments and how much to give to the beneficiaries each time a payment is made.
The beneficiaries of a discretionary trust do not have a right to receive or request money from the trust.
A discretionary trust is often set up in a Will. 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.
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 will not be included in the estate when calculating Inheritance Tax. It is important to take professional advice before setting up a discretionary trust however, as there will be other tax liabilities and you need to be sure that the option is beneficial.
To provide for a particular class of beneficiary
A discretionary trust can be set up to provide for beneficiaries who have not yet been born. For example, if more grandchildren are born, the trustees can provide for them as necessary. 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.
To protect the trust funds from being spent unwisely
Some individuals may not have the ability to manage large sums of money. 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. However, the bulk of the funds will be protected from unwise spending.
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 are older. The trustees can decide to end the trust at this point if they wish. Alternatively the trust could be set up to last until the beneficiaries reach a particular age.
If an individual has problems, for example, with addiction, the trustees could decide to hold on to the trust funds. Subsequently only releasing money to them for certain purposes.
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. For example, if a beneficiary is made bankrupt, their trustee in bankruptcy cannot demand money from the trust. However, if payments are made to a bankrupt individual, 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 is likely to end these benefits. Placing money into a discretionary trust, means that the beneficiary’s means-tested benefits should not be affected. They do not have a 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 provides guidelines about how and when they would like the money distributed. Trustees are not bound by this, but they should take your wishes into consideration.
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