WHAT IS A DISCRETIONARY TRUST

Updated: Aug 9

A discretionary trust may be established for the benefit of the settlor's spouse or civil partner, as well as his or her children and grandchildren, or an entirely separate class of beneficiaries. In practise, trustees of discretionary trusts often consider any instructions supplied by the settlor in a letter of wishes, although they are not required to do so by law. You are encouraged as the settlor to prepare a letter of wishes, but emphasise that the trustees are not required to adhere to it and must use their own discretion in managing the trust.


REASONS FOR A DISCRETIONARY TRUST


A discretionary trust may be suitable for a settlor who wants to:

  • Provide for several beneficiaries, allowing the trustees flexibility in managing the trust's assets based on the beneficiaries' circumstances and tax rules.

  • The settlor may want to do this during their lifetime, rather than in their will, so that they may oversee the early administration of the trust and ensure that all preparations are in place before they pass away.

  • Provide for beneficiaries without granting them capital or earning rights. The settlor may be concerned that if the beneficiaries are given capital or income outright they will:

  1. mismanage the funds;

  2. risk losing the funds via divorce or insolvency; or

  3. lose eligibility for means-tested state benefit.

WHEN NOT TO USE A DISCRETIONARY TRUST


A discretionary trust may not be suitable if:

  • The grantor does not want the trustees to have discretion over the distribution of the trust's assets among the beneficiaries.

  • Relationships between beneficiaries that are strained are likely to result in challenges to the trustees' choices.

  • Shares with significant dividend income are currently included in the trust fund or may be in the future. Because dividends paid to discretionary trustees and distributed to beneficiaries are subject to a higher rate of income tax than dividends paid to beneficiaries directly or through an interest in possession (IIP) trust.

  • The proposed trust fund's worth is insufficient to justify the trust's expense.


TAXATION OF DISCRETIONARY TRUSTS


INHERITANCE TAX


For the purposes of inheritance tax (IHT), a discretionary trust is a relevant property trust (unless it qualifies as a disabled person's interest). This implies:

  • Transfers that are charged are additions to the trust. If the value of the assets is more than the settlor's available nil rate band (NRB) at the time of the addition, there is an instant IHT charge of 20% (entry charge). Check to see whether the settlor made any other potentially exempt transfers or chargeable transfers in the seven years prior to the creation of this trust (such as by establishing other trusts). The previous transfers will retroactively diminish or eliminate the NRB accessible to the settlor at the time of its establishment if they pass away within seven years of the trust's inception.

  • Every 10 years, taxes may become due (ten-year anniversary charge).

  • When assets cease to be relevant property, there is a charge on the decrease in value of a trust fund (exit charge). Based on how many quarter years have passed since the beginning of each ten-year term.

  • Pilot trusts are now subject to anti-avoidance measures enacted by the Finance (No. 2) Act 2015. Exit and ten-year anniversary costs accruing on or after November 18, 2015 must follow these regulations. They don't alter how admission fees are determined.

CAPITAL GAINS TAX


The primary characteristic of the capital gains tax (CGT) laws for discretionary trusts is that hold-over relief is often available both at the time of trust creation (barring the case where the settlor has an interest in the trust) and at the time when assets are dispersed to beneficiaries. This indicates that a settlor may establish a discretionary trust within the limits of their NRB without incurring an initial IHT or CGT liability.


INCOME TAX


Discretionary trusts are subject to special trust rates of income tax and complex restrictions when trustees transfer income to beneficiaries. You need to read more in order to learn more about how discretionary trusts are taxed.


CREATING DISCRETIONARY TRUST


Anyone may create a discretionary trust, but not everyone knows how to do it properly. In the event that you die away, having a discretionary trust that specifies how you want your assets divided in the event that you are not around to make that decision might greatly reduce the stress on your loved ones. When you are unable to make a decision, it's feasible that a discretionary trust might provide the clarity of a fair result. You can give this duty to someone who will make a wise choice on your behalf.


Additionally, you have a fantastic opportunity to make plans for the future of your family and other important individuals. You are able to create plans thanks to it. It might not be fair under the circumstances if I give all of my children an identical amount of money. I should give the most meritorious or least fortunate child a gift for a really equitable distribution. You have the potential to avoid a 40% inheritance tax levy and the ability to engage in financial planning if your assets exceed the threshold for the nil rate categories.


If you have a discretionary trust, you may manage complex family situations including marriage, divorce, remarriage, life interests, and trusts. You can create a discretionary trust that meets your needs. This book will help you start thinking about how to fill that knowledge gap by exploring all you need to know about setting up a discretionary trust.


It makes it simpler for readers to apply the knowledge to their own situations by explaining how to do so. Everybody's situation is different. The advice in this book will be very useful to you as you think about your own circumstances and how you may start making arrangements to form a discretionary trust. The book's end includes a discretionary trust deed template and a letter of wishes that show how the fundamental discretionary trust should be structured.



Creating a discretionary trust

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