What is a Discretionary Trust?
Like all Trusts, it is a ‘legal entity’ set up for a specified purpose and run by its appointed Trustees. In the case of a Discretionary Trust the Trustees responsible for how the Trust is run and how the beneficiaries of the Trust are looked after.
The Trustees have ‘discretion’ as to how the income received by the Trust is used. They may also have control over how that income and capital is distributed amongst the beneficiaries.
What can the Trustees decide?
Trustees can determine and control various aspects of the Trust including:
- How much of the Trust is paid out to individual beneficiaries
- Which beneficiaries receive payments and which don’t (if any)
- How often payments to beneficiaries are made
- What conditions are imposed on beneficiaries
The extent of a Trustee’s discretion depends on the conditions laid out by the Trust’s creator.
What kind of specifications can be made?
The person who sets up the Trust can indicate through a “Letter of Wishes” when capital and income from the Trust should be used. They may, for example, ask for a provision for extra capital to be used for any grandchild’s higher education costs. If a beneficiary is incapable of dealing with money by themselves, a it can be ‘suggested’ that the Trustees oversee any financial arrangements made on behalf of that beneficiary. This is often the case if the beneficiary is mentally or physically disabled or is a child below the age of 18. These types of Discretionary Trusts may qualify for special tax exemption or conditions.
What sort of situations warrant a Discretionary Trust?
A range of situations might benefit from the use of a Discretionary Trust:
- fluid or complex inheritance issues – final decisions are left to the Trustees
- wayward children – addiction, divorce or business problems that require delayed inheritance
- complex tax issues – wait and see what’s best at the time
Taxation
The Trustees of a Discretionary Trust are responsible for dealing with all issues concerning taxation.
Income tax may be payable and if there is more than one Trust, the standard rate band is divided between the trusts. For Trusts whose primary beneficiary is someone considered to be a ‘vulnerable beneficiary’, special rates of tax are applied.
- Capital Gains Tax is payable on the profits of any sale or transfer of assets including property, shares or possessions.
- Inheritance Tax is currently levied at 6% every ten years on the taxable amount above the Nil Rate Band.
Discretionary Trusts are an ideal way to distribute the assets of an estate fairly between multiple beneficiaries who may have different requirements at different times, but because of the potential tax implications involved, it is best to talk to an expert if you wish to set up a Discretionary Trust for your beneficiaries.
This information is provided is based on UK law and is relevant to UK taxpayers. It is for information only and should be independently verified in each case.
