Trust Solicitors

A discretionary trust is a trust where you nominate a range of potential beneficiaries (usually spouses, children, and grandchildren). You will appoint trustees who will be in charge of managing the trusts. Who you appoint as trustees will depend on the circumstances and your reasons for using the trust.

The trustees have complete discretion to pay out income and/or capital from the trust to any of the beneficiaries listed at any time. No beneficiary has an automatic right to the funds. They cannot demand funds and not one of the beneficiaries actually owns any of the trust assets. As no one has an entitlement to the assets in the trust (unless the trustees decide that they do), the assets in the trust do not belong to any individual beneficiary and are not inside their estate at death. Similarly, they do not belong to any individual beneficiary if they should get into financial difficulties or get divorced (although assets in trust on divorce may be challenged by a matrimonial court).

Discretionary trusts are used for a variety of reasons including tax-efficiently passing wealth on to grandchildren and further descendants and protecting assets and vulnerable beneficiaries.

This sort of trust can be useful for protection from care fees if an individual leaves assets to a trust instead of the surviving spouse upon death. If the surviving spouse goes into care, the assets in the trust are not within the survivor’s estate and the local authority cannot recoup them towards care fees.

The trust can last for up to 125 years, allowing wealth to be passed down generations. If leaving assets to children directly will simply add to an already taxable estate, you may leave assets to a trust to pass them on to the grandchildren and further descendants.
Many people use trusts where they want a beneficiary to have the benefit of the funds but do not wish them to have control over them. For example, this may be due to the beneficiary being poor at managing money, having issues with addiction or being susceptible to outside influences. This sort of trust can also be used for minors or disabled individuals.

A discretionary trust offers flexibility. As the trustees have control over when funds are used or paid out, they can make the decisions based on the circumstances at the time.

Every individual has an inheritance tax (“IHT”) threshold of £325,000 before any inheritance tax is payable on their estate. There is also no tax to pay on gifts between spouses and it is possible to use the unused nil-rate band of the first spouse to die, against the second spouse’s estate when they die.

If an amount higher than the nil rate band is given to a discretionary trust, then there are inheritance tax implications.

When a trust holds assets to a value of more than £325,000 there is a charge to tax every ten years at a maximum rate of 6% on the assets in the trust which exceeds the inheritance tax threshold at that time. There is a proportionate charge on capital paid out of the trust between ten-year anniversaries.
If you set up a discretionary trust during your lifetime, rather than in your Will, then there will be an immediate charge to IHT at 20% on anything over the £325,000 threshold being transferred into the trust.

Assets that benefit from business property relief do not suffer IHT at any time.

Please note that the new residence nil rate band will not apply where the property is left to a discretionary trust. However, it should be possible to distribute the asset out of the trust to eligible beneficiaries within two years of death. This should therefore not deter people from leaving assets to a discretionary trust if it is a good option for their circumstances. You should ensure that your trustees will get the proper advice at the time so that the trust assets are managed in the most tax-efficient way.

Trusts pay CGT at a rate of 20% for the tax year 2021/2022. However, there is an additional surcharge for CGT on residential property of 8%. So, gains on the sale of residential property from a trust will be taxed at 28%. Trusts have an annual exemption equal to half that of an individual, so currently £6150, which can be used against the gain before any CGT is payable.

Entrepreneur’s relief may be available in certain circumstances.

If the trust is going to receive income, then you need to be aware of the income tax implications. Discretionary trusts pay income tax at the basic rate on their income below £1,000 per annum. Above that, for the tax year 2021/2022 they pay tax at the rate of 45% on the majority of income and 38.1% on dividends. Trusts do not benefit from the £5000 tax-free allowance for savings income.

Beneficiaries who receive income from the trust, and who pay tax at lower rates (or not at all), can reclaim the difference. In addition, if a beneficiary has an entitlement to trust income (which the trustees can decide to create, or revoke), then the share of the trust income which they receive is treated as their own income and taxed accordingly. For this reason, it is usual to mandate the trust income to individual beneficiaries or to invest in non-income-producing assets.

This is a guide to be used alongside specific advice regarding your circumstances. Please do let us know if you want to discuss the above points in more detail.