Discretionary trusts are a powerful tool in estate planning, offering flexibility and protection for your assets while ensuring that beneficiaries are cared for according to your wishes. However, setting up and managing a discretionary trust can be complex, and mistakes can have costly consequences for you, your trustees, and your beneficiaries.
At Blackstone Solicitors, we help individuals and families across England and Wales navigate the intricacies of discretionary trusts. In this article, we’ll outline the most common mistakes people make when setting up or managing discretionary trusts—and how to avoid them.
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What Is a Discretionary Trust?
A discretionary trust is a legal arrangement where trustees hold and manage assets for the benefit of specified beneficiaries. Unlike other types of trusts, discretionary trusts give trustees the power to decide how and when to distribute income or capital to the beneficiaries. This flexibility makes discretionary trusts particularly useful for families with varying or unpredictable financial needs.
However, the flexibility of a discretionary trust also requires careful planning and ongoing management to avoid pitfalls.
Common Mistakes and How to Avoid Them
- Failing to Clearly Define the Beneficiaries
One of the most critical components of a discretionary trust is specifying the beneficiaries. If the trust deed does not clearly define who can benefit, disputes may arise, leading to costly legal battles or unintended exclusions.
How to Avoid This:
- Clearly list all intended beneficiaries in the trust deed, including any classes of beneficiaries (e.g., “children and grandchildren”).
- Consider including a “reserve power” for the settlor or trustees to add or remove beneficiaries in the future, allowing for flexibility as family circumstances change.
- Choosing the Wrong Trustees
Trustees play a vital role in managing the trust’s assets, making investment decisions, and deciding on distributions. Appointing the wrong trustees—whether due to lack of expertise, reliability, or impartiality—can lead to poor management, disputes, or even legal challenges.
How to Avoid This:
- Choose trustees who are trustworthy, financially literate, and capable of handling the responsibilities.
- Consider appointing a mix of professional trustees (such as solicitors or accountants) and family members to balance expertise and familiarity with family dynamics.
- Clearly define the trustees’ powers and duties in the trust deed to minimise misunderstandings.
- Neglecting Tax Implications
Discretionary trusts are subject to complex tax rules, including inheritance tax (IHT), income tax, and capital gains tax (CGT). Failing to understand these obligations can lead to unexpected tax liabilities for the trust and its beneficiaries.
How to Avoid This:
- Work with experienced professionals to understand the tax implications of setting up and managing a discretionary trust.
- Plan for potential IHT charges, such as the 20% entry charge on contributions above the nil-rate band and the 10-year periodic charges.
- Keep detailed records to ensure accurate tax reporting.
- Creating a Trust Without a Clear Purpose
Setting up a trust without a clear understanding of its purpose can lead to confusion and ineffective use of the trust’s flexibility. This mistake often arises when individuals establish trusts to “tick a box” without properly considering their specific estate planning goals.
How to Avoid This:
- Clearly define the trust’s purpose before establishing it. Common purposes include protecting assets for future generations, providing for vulnerable beneficiaries, or managing inheritance tax.
- Discuss your goals with a solicitor to ensure the trust structure aligns with your intentions.
- Overlooking Trustee Powers and Restrictions
The trust deed is the foundation of the discretionary trust, outlining the trustees’ powers and responsibilities. Failing to include clear instructions or imposing overly restrictive terms can lead to mismanagement or limit the trust’s flexibility.
How to Avoid This:
- Include comprehensive provisions in the trust deed, covering investment powers, distribution rules, and administrative procedures.
- Allow trustees sufficient flexibility to respond to changing circumstances, such as a beneficiary’s financial needs or tax considerations.
- Periodically review the trust deed to ensure it remains relevant and effective.
- Neglecting to Review the Trust Regularly
Family dynamics, financial situations, and tax laws can change over time. A discretionary trust set up years ago may no longer reflect your intentions or the needs of your beneficiaries. Failing to review the trust regularly can lead to missed opportunities or unintended consequences.
How to Avoid This:
- Schedule periodic reviews of the trust with your solicitor to ensure it remains fit for purpose.
- Update the trust deed or letter of wishes as needed to reflect changes in family circumstances or legislation.
- Mismanaging the Trust’s Assets
Poor management of the trust’s assets can erode their value, reducing the funds available for beneficiaries. Trustees have a legal duty to manage assets prudently, but without proper guidance, they may make suboptimal investment decisions.
How to Avoid This:
- Ensure trustees understand their fiduciary duties and seek professional advice when needed.
- Consider appointing a professional trustee or investment manager to handle complex assets.
- Diversify the trust’s investments to balance risk and return.
- Failing to Provide a Letter of Wishes
A letter of wishes is an informal document that guides trustees on how you would like the trust to be managed and distributed. While not legally binding, it provides valuable context for trustees when exercising their discretion.
How to Avoid This:
- Draft a clear and detailed letter of wishes, outlining your preferences for distributions, priorities among beneficiaries, and any other relevant considerations.
- Update the letter of wishes as circumstances change.
- Ignoring the Administrative Burden
Managing a discretionary trust involves ongoing administrative responsibilities, including record-keeping, filing tax returns, and holding trustee meetings. Overlooking these requirements can lead to penalties or mismanagement.
How to Avoid This:
- Ensure trustees understand their administrative duties and have the resources to fulfil them.
- Keep thorough and organised records of all trust activities.
- Engage a professional administrator or solicitor to assist with compliance if necessary.
- Relying on DIY Solutions
While setting up a trust may seem straightforward, the legal and tax complexities involved mean that DIY solutions often result in costly mistakes. Relying on template documents or unqualified advice can leave your trust vulnerable to challenges or inefficiencies.
How to Avoid This:
- Work with an experienced solicitor to draft a tailored trust deed and provide guidance throughout the process.
- Avoid generic solutions and ensure the trust is designed to meet your specific needs.
How Blackstone Solicitors Can Help
At Blackstone Solicitors, we understand the challenges and intricacies of setting up and managing discretionary trusts. Our team provides expert advice and personalised solutions to help you:
- Define clear and achievable estate planning goals.
- Draft a robust trust deed that reflects your wishes.
- Navigate the tax implications of your trust.
- Select reliable and capable trustees.
- Ensure ongoing compliance and effective management of the trust.
Conclusion
Discretionary trusts are a valuable tool in estate planning, offering flexibility and control while protecting your assets for future generations. However, avoiding common mistakes is essential to ensure the trust operates as intended and provides maximum benefit to your beneficiaries.
By working with experienced professionals, you can avoid these pitfalls and create a trust that meets your family’s needs, now and in the future. At Blackstone Solicitors, we are here to guide you every step of the way. Contact us today to discuss how we can help you with your discretionary trust and broader estate planning needs.
We have a proven track-record of advising upon all aspects of private client work. We will guide you through the process and ensure all checks are carried out swiftly and efficiently and we firmly believe that with the right solicitors by your side, the entire process will seem more manageable and far less daunting.to incorporate, what kind of ownership
How to Contact Our Private Client Solicitors
It is important for you to be well informed about the issues and possible implications of dealing with trusts. However, expert legal support is crucial in terms of ensuring a positive outcome to your case.
To speak to our Trust 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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