Understanding Discretionary Trusts: A Flexible Estate Planning Tool

When it comes to estate planning, ensuring your assets are managed and distributed according to your wishes is essential. Discretionary Trusts offer a flexible and powerful way to provide for your beneficiaries while retaining control over how and when they benefit. This blog explains what discretionary trusts are, their advantages, and how they might work for your estate planning needs.

What Is a Discretionary Trust?

A discretionary trust is a type of trust where the trustees have full discretion over how to manage and distribute the trust assets among the beneficiaries. Unlike fixed trusts, where beneficiaries are entitled to specific shares, a discretionary trust allows flexibility in addressing the needs and circumstances of each beneficiary over time.

The key elements of a discretionary trust include:

• Settlor: The person who creates the trust and transfers assets into it.

• Trustees: Individuals or entities responsible for managing the trust and making decisions about distributions.

• Beneficiaries: The people or organisations who may benefit from the trust, as defined by the trust deed, of which the Settlor can be one.

• Trust Deed: The legal document that outlines the terms and rules of the trust.

• Letter of Wishes: A crucial document that accompanies the trust deed, providing guidance to trustees about how the settlor would like the trust assets to be managed and distributed. While not legally binding, it offers clarity and ensures the settlor's intentions are considered.

Advantages of Discretionary Trusts

1. Flexibility: Trustees can adapt distributions based on beneficiaries' changing circumstances, such as financial needs or personal situations.

2. Asset Protection: Assets in the trust are protected from creditors or potential claims against individual beneficiaries.

3. Tax Efficiency: A discretionary trust can help manage inheritance tax (IHT) liabilities and provide tax planning opportunities.

4. Control: The settlor can establish detailed instructions in the trust deed, allowing them to guide how trustees should manage the assets.

5. Support for Vulnerable Beneficiaries: Discretionary trusts are ideal for providing for vulnerable individuals who may be unable to manage assets themselves.

Common Uses for Discretionary Trusts

• Protecting Inheritance for Future Generations: Ensuring wealth is preserved and passed on as intended.

• Providing for Minor Children: Discretionary trusts can hold assets for children until they reach a certain age or maturity level.

• Managing Wealth for Vulnerable or Disabled Beneficiaries: Ensures that beneficiaries can receive support without affecting their eligibility for means-tested benefits.

• Reducing Inheritance Tax: Assets placed in a discretionary trust may fall outside the settlor’s estate for IHT purposes after seven years.

How Discretionary Trusts Are Established

Discretionary trusts can be established in two main ways:

1. By Will: A discretionary trust set up through a Will takes effect upon the death of the settlor, allowing assets to be managed and distributed according to the settlor’s wishes posthumously.

2. Lifetime Trusts: These are created during the settlor's lifetime and can immediately begin managing assets. Lifetime discretionary trusts can also be "settlor-interested," meaning the settlor retains some interest in the trust, such as receiving income or other benefits, though this has specific tax implications.

Tax Implications of Discretionary Trusts

Discretionary trusts have their own tax rules, including:

• Inheritance Tax (IHT): A charge of up to 20% may apply when transferring assets into the trust if the value exceeds the settlor’s available nil-rate band.

• Periodic Charges: A 10-yearly IHT charge may apply to the value of the trust assets exceeding the nil-rate band.

• Income Tax: Income generated by trust assets is taxed at the trust rate, which can be higher than individual tax rates.

• Capital Gains Tax (CGT): Gains made by the trust may be subject to CGT, but trustees can utilise an annual exemption.

  
  

How to Set Up a Discretionary Trust

Setting up a discretionary trust involves:

1. Choosing Trustees: Select reliable and capable individuals or entities to manage the trust.

2. Drafting the Trust Deed: Work with a professional such as Toucan Law to create a legally sound document outlining the trust’s terms.

3. Transferring Assets: Move assets into the trust, ensuring compliance with any applicable tax regulations.

4. Defining Beneficiaries: Clearly identify who may benefit from the trust.

5. Creating a Letter of Wishes: Provide trustees with detailed guidance to help them understand your intentions for the trust.

   
   

How Toucan Law Can Help

At Toucan Law, we specialise in creating and managing discretionary trusts. Our team can guide you through:

• Understanding whether a discretionary trust suits your needs.

• Drafting a comprehensive trust deed.

• Advising on tax implications and planning opportunities.

With our expertise, you can ensure your estate plan protects your assets and supports your loved ones.

Make the Right Choice for Your Estate

Discretionary trusts offer unmatched flexibility and protection, making them a valuable tool for many estate plans. Contact Toucan Law today to learn how a discretionary trust can secure your assets and provide for your family’s future.