What you need to know about discretionary trusts in wills

What are the advantages and disadvantages of discretionary trusts? Emma Beckett, Head of Wills & Probate at GWlegal, explains what you need to know about discretionary trusts created by wills.

What is a trust?

A trust is a legal arrangement created either during lifetime by deed or on death under a will whereby a third party (the trustee(s)) holds property on behalf of another person or persons (the beneficiaries). Property includes the income and capital of the asset. The asset can be:

land
money
property
investments
shares

If the asset consists of land, at least two trustees are required.

What is a discretionary trust?

A discretionary trust is a type of trust which gives the trustees a considerable amount of flexibility as it is up to them to decide:

who benefits from the trust property out of the people named as potential beneficiaries
when the potential beneficiaries receive the trust property
how much they receive (if anything at all)

Why set up a discretionary trust?

There are a number of reasons why a person might choose to set up a discretionary trust within their will. Discretionary trusts can be useful to provide for people who are considered vulnerable due to a disability or condition or because of potential pressures from other people if they were to receive the money outright.

Discretionary trusts typically last for up to 125 years from the date of the death of the person who made the will (the testator). Provided the will gives the trustees the power to do so and there are sufficient assets remaining in the trust, this can enable future generations to benefit from the trust property who may not otherwise have benefitted from the inheritance.

Peace of mind can be afforded to the person setting up the trust in their will knowing that assets will be controlled in their absence by a suitable trustee of their choice, who can take into account what they may have done had they still been around, as well as the beneficiary and their lifestyle when deciding how best to distribute the trust funds. This can be particularly helpful with larger estates, where assets can be released over many years so that funds are available to assist the potential beneficiaries during their various life stages.

What factors do trustees consider when distributing assets?

A separate letter of wishes is usually prepared alongside the will to give guidance to the trustees regarding how the testator wants the assets from the trust to be distributed, but what is said within this letter is not binding and ultimately the trustees can choose to ignore it.

Trustees must assess the individual needs and personal circumstances of the potential beneficiaries. They are under a duty to always act in the best interests of the trust when making any decisions. If they do not, they can be held to account for their actions.

The tax implications of whether to distribute the assets from the trust and when are also an important consideration. These include charges to tax every 10 years post-trust set up and exit charges on assets that are appointed out to beneficiaries.

What are the advantages and disadvantages of discretionary trusts?

Advantages

There are many advantages to discretionary trusts, including:

flexibility and control – the trustees have the flexibility to adapt distributions according to the needs of the beneficiaries
asset protection – assets held by a discretionary trust are not owned by the beneficiaries meaning it allows for passing down wealth to future generations
preservation of benefits – having assets in a discretionary trust can mean that vulnerable beneficiaries are able to retain their benefits which can be especially important if receiving the inheritance outright would put them in a worse position financially long-term
tax reasons - they can be used to preserve potential inheritance tax reliefs such as business and agricultural property relief

Disadvantages

However, there are some potential issues which can arise when using discretionary trusts, including:

loss of control – trustees have the ultimate say about who receives what and when and they can ignore the testator’s wishes
family feuds – there may be beneficiaries who feel as though aggrieved that they have not been left anything outright and it could result in potential claims against the testator’s estate
cost – discretionary trusts can be expensive to run due to ongoing fees for professional advisors, tax and out of pocket expenses incurred by the trustees
responsibility – for the trustees, discretionary trusts can be a huge administrative and emotional responsibility due to ongoing record keeping and submission of tax returns and navigating relationships with the potential beneficiaries can be difficult
potential loss of the residence nil rate band – if the deceased’s estate is taxable and the residue has been left in a discretionary trust rather than to direct descendants, the residence nil rate band will be lost and considerably more inheritance tax will be payable unless the trustees take appropriate advice regarding appointing the property out of the trust within 2 years from the date of death

Summary

There are many factors to take into consideration when deciding whether to set up a discretionary trust in a will. They are a considerable responsibility for the trustees to take on and careful consideration should be given to who to appoint. Discretionary trusts could also result in disgruntled relatives who may not understand why they are not automatically entitled to receive money from the estate. However, the flexibility of discretionary trusts allows for unknown future situations and enables the trustees to take account of the personal needs of the potential beneficiaries at any particular time.

Emma Beckett GW Legal