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What is a discretionary trust and what are the benefits of using one?

Clients often ask about trusts and are concerned they will be very complicated. Whilst trusts do need to be run properly, they can also be very useful.

What is a trust?

A trust is an arrangement whereby a person (the settlor), transfers property to others (trustees), to hold for the benefit of beneficiaries. Trusts can arise in numerous ways, such as by deed in a person’s lifetime or on death in a person’s Will. There are also many different types of trusts e.g. discretionary trusts, life interest trusts, bare trusts; each with different terms and uses, but here we will look specifically at discretionary trusts.

What is a discretionary trust?

This is a very flexible form of trust, whereby property is held by trustees for the benefit of a number of beneficiaries. However, each beneficiary’s entitlement is not fixed, and instead, their benefit from the trust (in respect of income or capital) is left to the discretion of the trustees. Simply because someone is included within the class of beneficiaries is no guarantee that they will receive anything. These trusts can last for a maximum of 125 years, although they rarely do and the trust can be brought to an end at any time before that by the trustees.

Why use a discretionary trust?

Discretionary trusts are useful in a number of circumstances, such as where someone wishes to benefit a group of people (e.g. children and grandchildren) but is not sure which of them will need financial help and what their circumstances will be. A trust can also allow the distribution of assets to be rebalanced, where lifetime gifts have been made. A trust can also offer protection to beneficiaries who are divorcing or those at risk of financial exploitation as a result of drug or alcohol issues, or who struggle to manage money. Assets in a discretionary trust are disregarded for beneficiaries in calculating means-tested benefits.

Discretionary trusts also have the advantage that the trust assets remain outside the beneficiaries’ estates for tax purposes, allowing wealth to be passed to future generations without incurring unnecessary inheritance tax charges.

Do you pay tax on discretionary trusts?

Trusts are not tax-free and do have their own taxation regime in respect of the three main taxes (income tax, capital gains tax and inheritance tax). They also need to be administered properly, but are a great way of benefiting others whilst retaining some element of control over the trust fund.

Transferring assets into a trust is classed as a gift and so is chargeable to inheritance tax on the settlor, but if the value of the assets transferred is less than the settlor’s inheritance tax allowance, there is no immediate tax liability. As with other gifts, if the settlor dies within seven years, then the value would still be added back to the estate for the purposes of calculating inheritance tax due.

A discretionary trust will not be appropriate for everyone, but there are many circumstances where this type of trust can be useful.

We would always recommend seeking advice and if you would like assistance in deciding if a trust may be helpful to you, please contact our Wills, Probate, Tax & Trusts team on 01332 265 959


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