A discretionary trust is a type of trust where the trustees are given complete discretion to pay or apply the income or capital of the assets for the benefit of one or all of the beneficiaries. They have control over how much to distribute at any given time, when to make distributions and who to make them to. No particular beneficiary has an interest in the trust or an entitlement to the trust funds – they only have a potential interest until the trustees actually exercise their discretion in their favour.
As the trustees have complete discretion over the trust funds, it is advisable for the testator to write a letter of wishes accompanying the Will which provides some guidance to the trustees in how they would like the assets to be distributed. It is important to note that letters of wishes are not a legally binding document and therefore there is no obligation placed on the trustees to follow them.
The aim of this type of trust is to provide flexibility. This could mean that trustees have the flexibility to adapt the money paid to beneficiaries in accordance with their changing needs etc.
What are the benefits of this type of trust?
- Protects a beneficiary’s share where they are financially unstable
- Tax saving reasons
- Protecting the benefits of a vulnerable beneficiary
- Safeguarding money from a beneficiary who is currently going through or likely to go through a divorce.
Taking each point above in turn, some beneficiaries may not be trusted to manage large inheritances and the testator may be worried that it will all be spent at once. The benefit of using a discretionary trust here is that the trustees will manage the fund, giving money to the beneficiary as and when they will require it and can essentially drip feed funds. Let us not forget the trustees do have complete discretion, so if a beneficiary with spending habits wants to purchase a top of the range sports car, the trustees are well within their remit to refuse this request.
Holding funds in the trust will also protect the money from the beneficiary’s creditors or potential bankruptcy. It is also useful where the beneficiary has a drink, drug or gambling problem and the testator does not want to gift the monies to them directly for fear it could exacerbate their addiction.
A discretionary trust can be used to ensure agricultural property relief or business property relief is used.
A discretionary trust can also be used to preserve funds for a minor until they attain an age where they can manage the money for themselves, or to protect funds for beneficiaries beyond their age of majority – even if there are no concerns of addiction. Some beneficiaries may have already reached the IHT threshold and do not want the inheritance they are to receive to increase the size of their own estate. In this situation, the trustees could simply lend the money to the beneficiary.
These types of trusts are also commonly used by those looking to drip feed money to vulnerable beneficiaries to avoid them from losing any benefits they are entitled to.
Lastly, it can be used to safeguard money from a beneficiary that is going through a divorce. The benefit of entering their share of the estate in this trust is that the trust funds will not be treated as belonging to the beneficiary as the trust owns the assets and will therefore fall outside of the beneficiary’s estate.
It is important to remember that a discretionary trust requires a minimum of two beneficiaries due to the discretionary factor the trustees have. Beneficiaries can either be individuals or classes i.e. “my children.”
A discretionary trust can last for a maximum of 125 years; therefore, it is important to consider who the default beneficiaries will be i.e. those who will inherit the trust fund when the trust ends. Please see our earlier article setting out the common errors when drafting a discretionary trust. The trust can end earlier in instances where all of the beneficiaries have died, or if the trustees have decided to wind down the trust and distribute the trust assets accordingly.
A discretionary trust is subject to the relevant property regime. Therefore, if the funds in the trust exceed the nil rate band, anniversary and exit charges will apply.
It is important to note that where a main residence passes to a discretionary trust, the RNRB will not apply. However, the RNRB could be recovered if the property is appointed out to direct descendants within 2 years of the testator’s date of death due to section 144 of the Inheritance Act 1984. However, this is likely to cause extra expense to the estate so we would advise the main residence is addressed separately in the Will.
4th September 2020 at 4:46 pm
Very good article, concise, and an easy read
Gillian Dawn McBurnie
7th September 2020 at 10:13 am
Thank you Manisha
8th September 2020 at 12:42 pm
A clear and concise article about discretionary trust pros and cons.
However it would be beneficial if more technical information about who and how these trusts can be set up . Eg can a SWW member set this trust up within a WILL or do they need to use a Solictor or the SWW trust corporation?
9th April 2021 at 3:35 pm
Thank you for your message and apologies for the delay in our response.
With regards to how these trusts are set up, as we don’t advise on probate, this is something you would need to discuss with your probate provider. A discretionary trust would be included in the Will and drafted by the will writer
6th November 2021 at 12:35 pm
Very useful article
I am comparing a residue with a FLIT OR a Discretionary Trust which mainly consist of the main residence of the testator and his spouse.
In a FLIT the spouse will be the life tenant and will reside in the main residence . When the spouse dies the value of main residence will form part of her esatate and will be chargaeble to IHT
In a discretionary trust- by letter of wishes the testator wants the Trustees to give his spouse a right to occupy the property. Question-when the spouse dies will the main residence form part of her estate and chargaeble to IHT
RNRB in both the above scenario is not available unless the use the s144 route within 2 years of death of the spouse
10th November 2021 at 8:52 pm
With a discretionary trust none of the beneficiaries have an interest in the trust as the asset belongs to the trust and not them individually. Therefore the main residence will not form part of the spouse’s estate for IHT purposes.
18th January 2023 at 1:15 pm
If a testator wishes to give his estate on absolute shares and protective trusts, but no solicitor or will writer is prepared to act as a trustee and there are no suitable family trustees, so that he is forced into a discretionary trust because he is given no other option, what is the best way of challenging the validity of the will?
20th January 2023 at 9:40 am
Hi Sidas, it would be uncommon for a solicitor or trust corporation to refuse to act as trustee or the client being forced to using a trust that does not meet his wishes. If he has capacity we would advise he see another will writer who can offer their advice. If the testator has passed away then you would need to seek legal advice.