The Discretionary Trust is a common Trust for a Testator to use for their children to ensure that they do not inherit directly from their estate. The reasons for this can vary, for example, protecting assets from potential divorce, drinking or gambling issues, or the testators may wish that their assets are distributed in a particular manner or at certain points in their children’s lives that are outside the capabilities of the Will itself.
This type of trust is effective because the assets are held and managed by the Trustees to distribute to the beneficiaries at their own discretion, hence the name of the trust and just because a beneficiary is named under the trust does not mean that they are absolutely entitled to any assets – useful where the Trustees may have concerns over how the money may be used. Where beneficiaries are named under the Trust; this can help to reduce the risk of Inheritance (provision for Family and Dependants) Act 1975 claims.
As the named Trustees are given complete control over the Trust it is highly recommended to not appoint just the beneficiaries as the Trustees. In some cases, such as more complex estates or families, it may be worth considering a professional such as the SWW Trust Corporation. A letter of wishes should underpin the Trust to guide the Trustees with how they wish the Trust to be run.
It's important to remember that a Discretionary Trust requires a minimum of two beneficiaries to maintain its discretionary nature. If there is only one beneficiary at the time of the benefactor's death, the assets held in the Trust are considered owned by that beneficiary, effectively making those assets an entitlement for them. This scenario typically arises when all beneficiaries of the Trust are explicitly named.
Trustees must have the discretion to choose which beneficiary to support. Therefore, a Discretionary Trust needs to have more than one beneficiary or at least the possibility of expanding the class of beneficiaries in the future. For example, if a client has one child but specifies the class of beneficiaries as "my descendants," this is acceptable because there may be potential future beneficiaries for the trustees to consider.
However, if the beneficiaries are a class of beneficiaries, such as ‘my descendants’ this would not cause the Trust to fail in this manner. Should there ever be one remaining beneficiary of the Trust, as it is legally possible for the number of beneficiaries in that class to increase, (for example, it is possible for that child to have their own children or adopt), the Trust can continue as if there is more than one beneficiary.
Discretionary trusts are subject to the relevant property regime. This will mean that if the trust’s assets are over the nil rate band (currently £325,000) the trust will need to pay anniversary and exit charges on the assets over the nil rate band. How these charges are calculated is complex but combined these charges will not exceed 6% of the value of which is above £325,000.If the value of the trust is below the nil rate band, there will be no ongoing inheritance tax charges. For inheritance tax purposes, the trust assets are seen as owned by the trust rather than by the beneficiaries of the trust.
Where a main residence passes into a Discretionary Trust, this would potentially lose the Residential Nil Rate Band (RNRB) as it cannot be applied to a trust of this type (unless a s89 Disabled Persons Trust, where different taxation rules apply). If the main residence does fall into a Discretionary Trust, then within 2 years from the date of the death of the Testator the Trustees could use s144 of the Inheritance Tax Act 1984 to appoint the property out to the direct descendants meaning that the RNRB can then be applied. However, caution must be used with this due to the time restraint and this can also lead to extra expense on the Estate, so where there are tax concerns the main residence should be kept separate.
The reasons to use a discretionary trust usually come down to either:
Discretionary trusts are usually written to last for 125 years, it is not possible for them to last any longer than this. The trust could be ended earlier than this, for example if all the beneficiaries have died (in which case the trust assets would pass to the default beneficiaries) or by the trustees distributing all the trust assets out to the beneficiaries.
The trustees of a discretionary trust have complete discretion on how to use the trust assets. Therefore, the trust itself won’t specify the distribution of the trust assets, such as what percentages the clients would want the beneficiaries to inherit or any other particular wishes they may haveAny particular wishes on how the trustees should exercise their discretion should instead be kept in a separate letter of wishes to the trustees. This can include wishes should as how much each beneficiary should inherit, at what ages and any concerns the testator may have over how the beneficiaries should inherit. The trustees would consider this letter but it is non-binding.
The Residential Nil Rate Band (RNRB) cannot apply if it is intended that the deceased’s main residence forms part of a discretionary trust and is to remain in the trust for the long term. However, if the trustees of the trust appoint the home out of the trust to direct descendants within two years of the testator’s death, RNRB will then apply. This is due to rules contained in S144 Inheritance Tax Act 1984 which mean that distributions from the trust within two years of death are treated for IHT purposes as if the will had gifted the assets to the beneficiary.
With thanks to Chris Rattigan-Smith
