What Is a Discretionary Trust?

by Daniel Wilson

24 February 2023

A Discretionary Trust are trusts where the settlor identifies the beneficiaries whom he/she wishes to potentially benefit, known as the ‘discretionary beneficiaries’, but the trustees decide which beneficiaries actually benefit, when and the extent of that benefit. Discretionary Trusts can be created in life by the settlor, or in death via a Will.

Discretionary Trusts differ from Life Interest Trusts because no automatic right to the enjoyment of the income or capital of the trust arises.

There are a number of reasons why a settlor may want to use a trust of this nature, including:

  • The settlor is unsure how they would like to plan ahead with regard to their estate and therefore wants the flexibility offered by using a discretionary trust.
  • The settlor wants to carry out some tax planning and reduce the value of his or her personal estate and take advantage of the relatively favourable tax treatment that is afforded to discretionary trusts. The assets placed in the trust no longer belong to the settlor once transferred and therefore the value of his estate is smaller.
  • The settlor wants to ensure that the assets placed in the trust are not considered to be within the control of the beneficiaries. This can also be important if one or more of the beneficiaries are experiencing financial or marital difficulties.

Advantages of using a Discretionary Trust

  • Discretionary trusts can last for decades and, where they are set up through a Will, it may be many years from the date of the Will before the settlor dies. The needs of discretionary beneficiaries change over the years. A discretionary trust enables the settlor to leave assets to be distributed by the trustees, who can then consider the circumstances of the discretionary beneficiaries at any time, not just when the trust is created or the Will is written.
  • A discretionary trust can also provide for beneficiaries who are not yet alive such as future grandchildren who can be included in the class of discretionary beneficiaries
  • The settlor normally expresses any wishes they have about how the discretion of the trustees is to be exercised through a Letter of Wishes. A Letter of Wishes is most commonly used when a discretionary trust is set up under the terms of a Will. For a discretionary trust set up during the settlor’s lifetime, the settlor will normally want to be a trustee of the settlement and can therefore express his or her views directly to the other trustees. You can read more about Letters of Wishes here.

Taxation of Discretionary Trusts
A discretionary trust is part of the ‘relevant property’ regime and will therefore be taxed at specific intervals for inheritance tax. Advice should be sought when utilising a discretionary trust to ensure compliance with the tax arising.

Get in touch

Should you have any queries in relation to any of the points mentioned within this update, please do not hesitate to get in touch with Daniel Wilson.

You can also find out more about our EMW Wealth team here.

The information contained in this update is for general information purposes only and is not legal advice, which will depend on your specific circumstances.

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