Discretionary trusts are a popular estate planning tool, often used to protect assets, minimise tax liabilities, and provide financial security for future generations. At Blackstone Solicitors, we specialise in assisting clients across England and Wales in setting up and managing trusts tailored to their needs. Here, we provide a comprehensive checklist to guide you through the key aspects of discretionary trusts.
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What is a Discretionary Trust?
A discretionary trust is a legal arrangement where assets are held by trustees for the benefit of a group of beneficiaries. Unlike fixed-interest trusts, the trustees have discretion over how and when to distribute income or capital among the beneficiaries. This flexibility makes discretionary trusts a versatile tool for a variety of circumstances.
Key Features of Discretionary Trusts
- Flexibility: Trustees decide how assets are distributed based on the needs and circumstances of beneficiaries.
- Control: The settlor (person creating the trust) can set guidelines for trustees through a letter of wishes.
- Tax Efficiency: Discretionary trusts can help manage inheritance tax (IHT) and protect assets from creditors or marital disputes.
- Confidentiality: Trusts are private arrangements, not subject to public probate.
Setting Up a Discretionary Trust: Checklist
- Identify the Purpose of the Trust
Before creating a discretionary trust, determine its primary purpose. Common reasons include:
- Protecting assets for vulnerable or young beneficiaries.
- Minimising tax liabilities.
- Providing for future generations.
- Safeguarding assets from creditors or marital disputes.
- Choose the Trustees
Trustees play a vital role in managing the trust and making decisions. When selecting trustees, consider:
- Number of Trustees: Typically, between two and four trustees are appointed to ensure balance and continuity.
- Trustees’ Skills: Choose individuals with financial acumen or legal knowledge where possible.
- Reliability: Trustees should be impartial, trustworthy, and capable of acting in the beneficiaries’ best interests.
- Professional Trustees: You may appoint a solicitor or financial professional to act as a trustee, particularly for complex trusts.
- Define the Beneficiaries
Clearly identify who the potential beneficiaries of the trust are. These may include:
- Specific individuals (e.g., children or grandchildren).
- A wider class of people (e.g., future descendants).
- Charities or organisations.
Ensure the trust deed includes sufficient flexibility to account for changes in family dynamics or beneficiaries’ circumstances.
- Draft the Trust Deed
The trust deed is the legal document that establishes the discretionary trust. It must:
- Clearly state the trust’s objectives.
- Name the trustees and beneficiaries.
- Outline the trustees’ powers and responsibilities.
Work with a qualified solicitor to ensure the trust deed complies with relevant laws and adequately reflects your intentions.
- Create a Letter of Wishes
Although not legally binding, a letter of wishes provides trustees with guidance on how you would like the trust to be administered. It can include:
- Preferences for income or capital distribution.
- Specific needs of beneficiaries (e.g., education, healthcare).
- Long-term goals for the trust.
- Transfer Assets to the Trust
Assets must be formally transferred into the trust for it to take effect. Common assets include:
- Cash or savings.
- Investments.
- Property.
- Life insurance policies.
Consider obtaining professional valuations for property or other valuable assets to ensure compliance with tax regulations.
Managing a Discretionary Trust: Key Considerations
- Tax Implications
Discretionary trusts are subject to specific tax rules. Trustees need to be aware of:
- Inheritance Tax (IHT): Trusts may face a 20% charge on assets transferred into the trust above the nil-rate band, with a 10-year anniversary charge and exit charge on distributions.
- Income Tax: Income retained by the trust is taxed at 45% (38.1% for dividends), although beneficiaries may reclaim excess tax depending on their individual tax rate.
- Capital Gains Tax (CGT): Trustees are entitled to an annual CGT exemption, but gains above this threshold are taxed at 20% (28% for property).
Professional advice is essential to optimise the tax efficiency of the trust.
- Trustee Duties
Trustees have a legal obligation to act in the best interests of the beneficiaries. Key duties include:
- Managing trust assets prudently.
- Keeping accurate financial records.
- Filing annual tax returns.
- Distributing assets in line with the trust deed and settlor’s intentions.
Regular trustee meetings and professional support can help ensure compliance with legal and tax obligations.
- Reviewing the Trust Regularly
Circumstances change over time, so it is important to review the trust periodically. Consider:
- Changes in beneficiaries’ needs.
- New tax legislation.
- Performance of trust investments.
Regular reviews with legal and financial advisers can help maintain the trust’s effectiveness.
Advantages and Disadvantages of Discretionary Trusts
Advantages:
- Flexibility: Trustees can adapt distributions to beneficiaries’ circumstances.
- Asset Protection: Trust assets are shielded from creditors and marital disputes.
- Tax Planning: Can reduce inheritance tax liabilities when structured correctly.
- Control: Settlor can provide detailed guidance through a letter of wishes.
Disadvantages:
- Complexity: Establishing and managing a trust requires careful planning and ongoing administration.
- Costs: Legal, accounting, and professional trustee fees can be significant.
- Tax Rules: Discretionary trusts are subject to complex and potentially high tax charges.
- Potential for Disputes: Ambiguities in the trust deed or disagreements among trustees can lead to disputes.
Final Thoughts
Discretionary trusts are a powerful tool for protecting assets and providing for future generations. However, they require careful planning, expert drafting, and ongoing management to achieve their intended objectives. By following this checklist and seeking professional advice, you can create a trust that meets your needs and offers long-term peace of mind.
How we can help
We have a proven track-record of helping clients create Trusts. We are a multidisciplinary firm and have all the expertise inhouse to satisfy the most exacting requirements of our clients. We will guide you through all the necessary legal due diligence in a comprehensive and timely manner. We firmly believe that with the right solicitors by your side, the entire process will seem more manageable and far less daunting.
How to Contact Our Wills and Probate Solicitors
It is important for you to be well informed about the issues and possible implications of creating a Trust. However, expert legal support is crucial in terms of ensuring your wishes are met as you would want them to be.
To speak to our Wills and Probate solicitors today, simply call us on 0345 901 0445, or click here to make a free enquiry. We are well known across the country and can assist wherever you are based. We also have offices based in Cheshire and London.
Disclaimer: This article provides general information only and does not constitute legal advice on any individual circumstances.
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