Advantages and Disadvantages of Discretionary Trusts

A discretionary trust is a type of legal arrangement where you can transfer assets or property to a trustee, who holds and manages those assets for the benefit of a group of beneficiaries.

Most people who set up discretionary trusts do so as part of their Estate and Inheritance Tax (IHT) planning and often put clauses in their Will to enable their setup.

In a discretionary trust, unlike most other types of trust, the trustee has the discretion to determine how and when the trust assets are distributed among the beneficiaries.

The trustee's discretion can have many legal implications, and it is important to be aware of these before deciding whether a discretionary trust is right for you, so you should always take qualified legal and financial advice.

How are discretionary trusts created?

If you create a discretionary trust through your Will, the trust will only take effect after you have passed away though they can also be setup during your lifetime.

Discretionary trusts are usually accompanied by a Letter of Wishes. This sets out how you wish your trustees to deal with the trust assets and can be used to explain your intentions behind the trust.

The benefits of discretionary trusts

There are many different reasons why you might wish to set up a discretionary trust. Some of the potential advantages are described below, though many of them will depend upon your circumstances and what you wish the trust to achieve.

1. Reducing the value of your estate In most cases, putting assets into a discretionary trust during your lifetime will serve to remove those assets from your estate, reducing the value of your estate at the time of your death when it is assessed for IHT.

Whilst it may be simpler to reduce your estate value by just making gifts during your lifetime, there could be situations where transferring an asset into a discretionary trust is preferable - for example where you would like several people to benefit from the asset, rather than giving the asset to a particular individual outright.

2. Providing for beneficiaries further into the future In some situations, you may wish to provide for certain loved ones, without them receiving the assets right away. You might prefer your appointed trustees to control the trust assets instead.

For example, you might feel your children or grandchildren are not mature enough to deal with large sums of money, or you do not wish to make gifts to children whose own estates would suffer increased IHT upon their death.

3. Flexibility Setting up a trust is often part of a long-term financial plan. Without knowing what the future holds, it can be difficult to predict which of your beneficiaries might be in greatest need of the trust assets later on.

Through a discretionary trust, your trustees can decide when and how the trust assets and income are to be divided amongst the beneficiaries, perhaps helping your loved ones in ways which you didn't imagine when setting up the trust.

In a similar way, a discretionary trust can allow you to provide for beneficiaries whom you may never meet, such as great-grandchildren for example.

The drawbacks of discretionary trusts

Some beneficiaries may receive nothing from the trust

Because trustees of a discretionary trust can choose which beneficiaries receive the trust assets, it is possible for them to decide that one or more beneficiaries should receive nothing. Even if this is your intention it can cause friction and be open to challenge.

Trustees are given a lot of responsibility

Discretionary trusts give a lot of power to the appointed trustees. This makes it even more important than usual to select your trustees with care and you may wish to consider appointing a professional as a trustee.

They can be complex

Connected to the above, is the complexity of administering a discretionary trust. You may feel that friends and family would be overwhelmed by the responsibility and complexity of handling a discretionary trust so again you could consider appointing at least one professional trustee alongside them.

Complicated tax arrangements

Tax can be a double-edged sword for discretionary trusts. Setting one up may reduce the IHT on your own estate but, in a number of situations, a discretionary trust will be taxed as its own separate entity - which means the trust will have to pay tax on the assets it contains.

It is important to be aware that discretionary trusts can save tax in some ways and incur it in others. While there is not space here to outline the complexity of tax arrangements associated with discretionary trusts it is an important reason for taking professional advice prior to setting up a trust.

Ask for Advice

Planning for your passing is one of the most important things you can do, but if you have a large family and a variety of assets it can be one of the most complicated things to plan. For most people though it is reassuring to know they have established the correct legal framework for passing on their assets, in the most tax efficient manner to their loved ones.

A discretionary trust is just one of the tools you can use to do this, but it must be done with expert legal and tax advice.

As Will Writers with many years' experience we understand how important it is to get all the details correct and we can discuss all the options at your disposal when planning your legacy. If you would like to find out more, require professional advice or have any questions about discretionary trusts or writing them into your will please contact us using the details below.

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