Discretionary Trusts: How To Ensure Your Children Inherit Your Estate

Estate planning is a crucial step in securing your family’s future and ensuring your children inherit your estate according to your wishes. One of the most flexible and effective tools available for this purpose is the discretionary trust. At Blackstone Solicitors, we understand that the concept of trusts may seem complex, but with the right advice, they can be a powerful way to manage your assets, minimise tax liabilities, and protect your children’s inheritance. This article will explain what a discretionary trust is, why it might be suitable for your estate planning needs, and how you can set one up in England and Wales.

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What is a Discretionary Trust?

A discretionary trust is a legal arrangement where assets are placed into a trust, managed by trustees who have discretion over how and when to distribute the assets to the beneficiaries. Unlike some other types of trusts where beneficiaries have a fixed right to the trust’s income or capital, discretionary trusts allow the trustees to decide which beneficiaries receive payments, how much they receive, and when they receive it.

The main advantage of a discretionary trust is its flexibility. The trustees can respond to changes in circumstances, making it particularly useful for protecting vulnerable beneficiaries, managing family wealth across generations, and ensuring that your estate is distributed in line with your evolving wishes.

Why Use a Discretionary Trust?

There are several reasons why a discretionary trust might be the right choice for ensuring your children inherit your estate:

1. Protection of Vulnerable Beneficiaries: If your children are young, have special needs, or are not yet financially responsible, a discretionary trust can help protect their inheritance. The trustees can manage the assets on their behalf and only make distributions when it is in the beneficiaries’ best interests.
2. Flexibility in Distribution: Life circumstances can change, and the needs of your children or other beneficiaries may evolve over time. A discretionary trust allows the trustees to make distributions that take into account current needs, such as paying for education, medical expenses, or supporting a family member in financial difficulty.
3. Inheritance Tax (IHT) Planning: Discretionary trusts can be useful in mitigating inheritance tax liabilities, as the assets placed in the trust are generally outside the settlor’s estate for IHT purposes. While there are specific rules on taxation of trusts, careful planning can help reduce the overall tax burden on your estate.
4. Protecting Assets from Third Parties: If there is a risk of your children’s inheritance being claimed by creditors, ex-spouses, or other third parties, a discretionary trust can provide a layer of protection. Since the beneficiaries do not have a fixed entitlement to the trust assets, the assets are generally more secure.

Now, let’s explore the steps you can take to set up a discretionary trust and ensure your children inherit your estate in the most efficient way possible.

1. Draft a Will Including a Discretionary Trust

The first step in using a discretionary trust for estate planning is to include it in your will. This will ensure that, upon your death, certain assets are transferred into the trust rather than being distributed outright to your beneficiaries. The trust can be set up to hold various assets, such as property, cash, or investments.

When drafting your will, consider the following key elements:

• Naming the Trustees: You will need to appoint trustees who will be responsible for managing the trust and making decisions about distributions. Choose individuals who are trustworthy, financially responsible, and preferably have some understanding of financial matters. It is possible to appoint a professional trustee, such as a solicitor, to ensure the trust is managed correctly.
• Identifying the Beneficiaries: While a discretionary trust does not give fixed entitlements to beneficiaries, you will need to identify a class of potential beneficiaries who could benefit from the trust (e.g., your children, grandchildren, or other family members). The trustees will then have the discretion to decide who should benefit and when.
• Setting Out Your Wishes: Although the trustees have discretion, you can provide them with guidance by writing a “letter of wishes.” This is not a legally binding document, but it helps the trustees understand your preferences regarding how the trust assets should be used.

At Blackstone Solicitors, we can help you draft a comprehensive will and set up a discretionary trust that aligns with your estate planning goals.

2. Transfer Assets into the Discretionary Trust

To fund the trust, you will need to transfer assets into it, either during your lifetime (creating a lifetime trust) or upon your death (through your will). The type and value of assets you choose to place in the trust will depend on your estate planning objectives, financial situation, and the needs of your beneficiaries.

Common assets transferred into discretionary trusts include:

• Property: If you own a family home or other real estate, placing it in a trust can help preserve its value for future generations while allowing the trustees to make decisions about its use (e.g., renting it out or selling it to fund other needs).
• Investments and Savings: Stocks, bonds, and other investments can be placed in a discretionary trust to generate income for the beneficiaries.
• Cash or Life Insurance Proceeds: Life insurance policies can be written in trust so that the proceeds pass directly into the trust upon your death, potentially avoiding inheritance tax.

Transferring assets into a discretionary trust can have tax implications, so it is advisable to seek professional legal and financial advice to understand any potential consequences.

3. Understand the Tax Implications

While discretionary trusts offer several estate planning benefits, they also come with specific tax rules that need to be considered. It is essential to understand how these taxes might affect your trust and estate:

• Inheritance Tax (IHT): When you transfer assets into a discretionary trust, there may be an immediate charge to IHT if the value exceeds the nil-rate band (currently £325,000). Additionally, there may be ongoing IHT charges, known as “periodic charges,” every ten years, and “exit charges” when assets are distributed from the trust.
• Income Tax: If the trust generates income, such as rental income from property or dividends from investments, the trustees are responsible for paying income tax on this income. The beneficiaries may be able to reclaim some of the tax paid by the trustees, depending on their individual circumstances.
• Capital Gains Tax (CGT): When assets are transferred into or out of a discretionary trust, CGT may be payable on any increase in the asset’s value. Trustees can claim certain reliefs, such as holdover relief, to defer the tax liability in some cases.

4. Appoint the Right Trustees

The success of a discretionary trust largely depends on the trustees you appoint. Trustees have a legal duty to act in the best interests of the beneficiaries and to manage the trust assets in accordance with the terms set out in the trust deed.

When appointing trustees, consider the following:

• Number of Trustees: It is advisable to appoint at least two trustees to ensure that decisions can be made without bias and to provide a check and balance system.
• Family Members or Professionals: While family members may have a better understanding of the beneficiaries’ needs, they may not have the necessary financial expertise. Professional trustees, such as solicitors or financial advisors, can offer impartiality and expert management.
• Replacement Trustees: Consider naming replacement trustees in the trust deed in case any original trustee is unable or unwilling to continue.

5. Keep the Trust Under Review

Once the discretionary trust is set up, it is important to keep it under regular review to ensure that it continues to meet your estate planning objectives. Changes in tax law, family circumstances, or the financial needs of the beneficiaries may warrant adjustments to the trust arrangements.

Regular reviews can help identify opportunities to improve the tax efficiency of the trust, make changes to the list of potential beneficiaries, or even decide whether to bring the trust to an end.

Conclusion

Setting up a discretionary trust can be a powerful way to ensure your children inherit your estate in a protected and flexible manner. With the ability to safeguard vulnerable beneficiaries, manage distributions according to changing needs, and reduce inheritance tax liabilities, discretionary trusts offer valuable estate planning benefits.

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.

Authored by Ben Posted in Blog, News Tagged as

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