A discretionary trust offers a unique and flexible way to protect your assets and ensure they are distributed to your beneficiaries according to your wishes. Discretionary trusts give trustees the power to decide how, when, and to whom the funds are distributed. This makes them an excellent tool for a variety of situations where flexibility and protection are key.
What is a Discretionary Trust?
A discretionary trust allows trustees to control the distribution of income and capital from the trust’s assets. Beneficiaries do not have an automatic right to the funds; instead, they hold a potential interest in the trust until the trustees exercise their discretion. This can offer an incredible amount of flexibility, especially when dealing with beneficiaries who have changing needs or circumstances.
While the trustees have full control, it is common for the person creating the trust (the testator) to write a letter of wishes, offering guidance on how they would like the funds to be distributed. However, it’s important to note that these letters are not legally binding.
Key Benefits of Discretionary Trusts
Protect Beneficiaries Who Are Financially Unstable
If a beneficiary has a tendency to make poor financial decisions or has issues managing large sums of money, a discretionary trust can be a safeguard. The trustees can distribute funds gradually, ensuring the beneficiary doesn’t waste the inheritance or fall victim to financial hardship.
Tax Savings
Discretionary trusts can be an effective strategy for tax planning. By managing the distribution of funds carefully, trustees can help minimize tax liabilities for both the trust and its beneficiaries.
Protection for Vulnerable Beneficiaries
A discretionary trust is ideal for protecting vulnerable beneficiaries, such as those with health problems, addiction issues, or those who might be easily exploited. The trustees can ensure that funds are used wisely and not squandered on harmful behaviors.
Safeguarding Funds During Divorce
A discretionary trust can help keep assets safe from a beneficiary’s divorce proceedings. Since the trust owns the assets, they are not considered part of the beneficiary’s personal estate and therefore can be protected from division during divorce.
How Does a Discretionary Trust Work?
Let’s break down how this trust can benefit your loved ones in real-life situations:
For Beneficiaries with Financial Instability: The trust allows trustees to manage the funds, giving money to the beneficiary as needed rather than in one lump sum. If a beneficiary wants to make a major purchase (e.g., an expensive sports car), the trustees have the discretion to deny the request if it’s deemed imprudent.
Protection Against Creditors: A discretionary trust shields the funds from the beneficiary’s creditors, preventing them from accessing the inheritance in cases of debt or potential bankruptcy.
Preserving Funds for Minors or Those Who Can’t Manage Money: The trust can hold funds for a minor until they reach an age where they are capable of managing their inheritance responsibly. It can also protect beneficiaries from an unwanted inheritance increase if they’ve already reached the Inheritance Tax (IHT) threshold.
Avoiding Benefit Loss: A discretionary trust can be a strategic way to ensure that vulnerable beneficiaries do not lose benefits they are entitled to, such as government support, by preventing a lump sum inheritance from impacting their eligibility.
Protecting Assets in Divorce: A beneficiary going through a divorce might benefit from having their inheritance placed in a discretionary trust, as the assets will be protected from the divorce settlement. Since the trust holds the assets, they remain outside the beneficiary’s personal estate.
Important Considerations
Minimum Beneficiaries: A discretionary trust requires at least two beneficiaries due to its discretionary nature. These beneficiaries can be individuals or classes (e.g., "my children").
Trust Duration: Discretionary trusts can last up to 125 years, which means the testator needs to consider who the default beneficiaries will be when the trust ends. Typically, these would be the heirs of the beneficiaries who have passed away. It is also important to consider when the trust should wind up—either when all beneficiaries have passed away or when the trustees decide to distribute the assets.
Relevant Property Regime: Discretionary trusts are subject to the relevant property regime, meaning that if the value of the trust exceeds the nil rate band, certain charges (e.g., exit charges) will apply.
Residence Considerations: If a main residence is left in a discretionary trust, the Residence Nil Rate Band (RNRB) may not apply. However, if the property is transferred to direct descendants within two years of the testator's death, it may be possible to recover the RNRB.
Conclusion
A discretionary trust is an excellent way to ensure your assets are distributed according to your wishes, while protecting your beneficiaries from potential risks such as financial instability, divorce, or addiction. By providing trustees with the flexibility to adapt the distribution based on the beneficiaries' changing needs, you create a lasting legacy that can provide for your loved ones for generations to come.
For tailored advice on setting up a discretionary trust, speak to us today!
Call 01926 897077 or email: anna@citywidewills.co.uk
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