Discretionary Trust
Discretionary Trusts are so called because the Trustees have complete discretion as to where income and capital are distributed amongst a defined group of beneficiaries. No beneficiary has a fixed entitlement or legal right to the income or capital.
The person who creates the Trust is called the settler. The Trust is usually created by the transfer of cash or assets in the settler’s lifetime, or on their death (by Will). Trust assets are held by the trustees, who manage and administer the Trust on behalf of the beneficiaries.
The transfer into Trust can be for the benefit of a class of beneficiaries as wide or as narrow as the settler chooses. Usually it is for the benefit of children, grandchildren and their respective spouses, but often the Trust includes the power to nominate additional beneficiaries.
The trustees powers are set out either in the Trust Deed (if a lifetime Trust), or in the Will. In many cases the settler will also sign a letter of wishes, guiding the trustees in the exercise of their discretions. Such a letter is not binding on the trustees, but very useful in practice.
It is usually possible for the Trust to continue for a period of 80 years, but the trustees have the power to bring the Trust to an end at anytime.
Discretionary Trusts allow individuals to transfer assets for the future benefit of a number of potential beneficiaries, whilst still retaining maximum flexibility over the distribution of income and capital.
Discretionary Trusts can make attractive Inheritance Tax planning vehicles, particularly if the initial amount transferred into Trust falls below the settler’s threshold for Inheritance Tax.
Discretionary Trusts are regularly used as part of Inheritance Tax planning for married couples. The couples Wills are drafted ensuring use of the Inheritance Tax ‘nil rate band’ amount on the first death. A Trust is created of which the surviving spouse is one of a number of potential beneficiaries.
The creation of a lifetime Discretionary Trust can also be a useful vehicle for unlocking the problem of transferring assets to future generations that might otherwise be tied up with large capital gains. When transferring assets into a Discretionary Trust the settler is able to ”hold-over‘ the capital gain to ensure no capital gains tax is payable on the set up of the Trust. In these circumstances the payment of tax is deferred until such time as the asset is subsequently sold by the trustees.
Many lifetime trusts start off in a discretionary form for this purpose. It is, however, always possible to adapt the nature of the Trust later, to take account of the tax situation and other circumstances.
Discretionary Trusts pay Income Tax at 40%. However, this maybe partly or wholly recovered to the extent that income is distributed to beneficiaries who are not higher rate taxpayers, e.g. to grandchildren or other minor beneficiaries.
It is essential that a Discretionary Trust is administered correctly. This involves the trustees maintaining proper Trust accounts and managing the Trusts’ assets, such as property or investments, appropriately. The trustees are under a legal obligation to file annual tax returns with HM Revenue and Customs and to issue appropriate tax deduction certificates to beneficiaries who have received income.
The amount of administrative work required will depend on the nature of the Trust assets and the frequency of distributions.
Because of the complexities and peculiarities of the tax calculations required for making distributions, it is advisable for trustees to seek professional help when administering a Discretionary Trust.
