What is a Discretionary Trust?

Firstly, a Discretionary Trust is a ‘legal device’ created by the person putting funds into it to benefit one or more people named as potential beneficiaries.

Like all Trusts, a Discretionary Trust is run by Trustees. In this instance however, the Trustees are responsible for making the decisions about how the Trust is run and how the beneficiaries of the Trust are dealt with.

The important feature of this type of Trust is that Trustees have ‘discretion’ as to how the income and capital is distributed amongst the beneficiaries.

What can a Trustee decide?

Trustees can determine and control various aspects of the Trust including:

How much of the Trust is paid out to individual beneficiaries
Which beneficiaries receive payments and when
How often payments to beneficiaries are made
What conditions are imposed on beneficiaries

The extent of a Trustee’s discretion depends on the conditions laid out by the Trust’s creator.

What kind of specifications can be made?

The person who sets up the Trust can specify when capital from the Trust can or should be used. They may, for example, make a provision for extra capital to be used for any grandchild’s higher education costs. If a beneficiary is incapable of dealing with money by themselves, it can be ‘suggested’ that the Trustees oversee any financial arrangements made on behalf of that beneficiary. This is often the case if the beneficiary is mentally or physically disabled or is a child below the age of 18. These types of Discretionary Trusts may qualify for tax exemptions.

Income Tax

The Trustees of a Discretionary Trust are responsible for dealing with all issues concerning taxation, including Income tax. Tax due on the income of the Trust is paid each year as part of an annual Trust and Estate tax return. Income is taxed at special rates, excluding the first £1,000 or ‘standard rate band’. If there is more than one Trust, the standard rate band is divided between the trusts. For Trusts whose primary beneficiary is someone considered to be a ‘vulnerable beneficiary’, special rates of tax are applied.

Capital Gains Tax

Capital Gains Tax is payable on the profits of any sale or transfer of assets including property, shares or possessions. Each year, an amount known as the ‘annual exempt amount’ allows Trustees to transfer or sell assets with a certain amount of value before Capital Gains Tax is payable. Any amount over that exemption rate is liable to Capital Gains Tax, which is paid by the Trustees.

Inheritance tax is currently levied at 6% every ten years on the taxable amount above the Nil Rate Band.

Payments to beneficiaries

If a beneficiary receives a discretionary payment from a Trust, it is subject to a tax credit at 40%. If the beneficiary is a non-taxpayer or pays only the basic rate of tax, they can then claim some or all of that tax back. A ‘tax pool’ allows Trustees to ensure that the correct amount of tax has been paid on all discretionary payments made from the Trust.

Discretionary Trusts are an ideal way to distribute the assets of an estate fairly between multiple beneficiaries who may have different requirements at different times, but because of the complex tax implications involved, it is best to talk to an expert if you wish to set up a Discretionary Trust for your beneficiaries.

One common use is when children are in difficult circumstances e.g. business is in severe finacial difficulties, addictions or going through divorce. all circumstances that would benefit from a flexible approach to how children might inherit.

You can find out more about Discretionary Trusts and making the right Will for your circumstances from Bill Ryan and if you like you can click contact Lawcapeto see all the contact methods.