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What is a Discretionary Trust?

Thinking about a time when you may no longer be here to support your child can be frightening. If your child has Special Educational Needs and Disabilities or is otherwise vulnerable, their future may feel especially uncertain, and it is natural to worry about how they will manage and what support they will need.

Without you, a vulnerable or disabled child may struggle to manage their finances and having a large inheritance in their own name may increase their vulnerability and put valuable means-tested support at risk.

Trusts for disabled beneficiaries

In our previous blog, “Planning for the Future to Protect your Child with Special Educational Needs and Disabilities”, we looked at how a Trust can help provide for a vulnerable or disabled beneficiary.

A Trust can give you peace of mind that the assets you leave behind, such as property, savings or investments, will be managed properly and used for your child’s benefit throughout their lifetime.

A Trust allows trusted individuals, known as Trustees, to hold and manage assets for the benefit of a vulnerable or disabled person. The Trustees decide how and when the assets are used, guided by the Trust document and a Letter of Wishes that sets out your intentions.

When planning for a vulnerable or disabled child, the choice is often between a Discretionary Trust and a Disabled Person’s Trust.

Our blog Trusts for Disabled People | Disabled Trusts Explained outlines when a Disabled Person’s Trust can be used and the rules that apply. In this article, we look at Discretionary Trusts in more detail and when they may be the more suitable option.

What is a Discretionary Trust?

A Discretionary Trust is a very flexible type of Trust as it can be used to benefit more than one person. You can include the beneficiaries you might want to benefit from the funds and this may be your disabled or vulnerable child, as well as other children, grandchildren, wider family and possibly a charity.

A Discretionary Trust is one where none of the beneficiaries have the right to income or capital and the Trustees have full discretion as to how they pay or apply income and capital for any of the beneficiaries. It’s for the Trustees to decide if, how and when the beneficiaries will benefit.

The beneficiaries do not have any fixed entitlement to receive money from the Trust, they only have a potential right to receive a benefit if the Trustees decide to do so. Therefore, the Trust and its assets cannot be taken into account when assessing a vulnerable or disabled child’s entitlement to means-tested benefits or Local Authority funding as they do not belong to the individual and that person has no right to benefit.

The Trustees can make decisions to meet any changing requirements of the vulnerable or disabled child and use their discretion to advance any amounts of capital or income depending on the needs of the beneficiaries at different times in their life.

Where a beneficiary is receiving means-tested benefits or support, the Trustees need to be careful how they use the assets. The assets should not be used in a way which endangers any future claim for means-tested benefits or support. Distributions directly to the them should not put that beneficiary’s total savings over the capital thresholds and Trustees should avoid regular payments to the beneficiary which could be viewed as income.

A Discretionary Trust can last for up to 125 years but, it is usually be wound up on the death of the disabled or vulnerable beneficiary, and any assets left are paid to the other beneficiaries of the Trust.

Due to its flexibility a Discretionary Trust can be very useful where the Trust will provide for more than one vulnerable beneficiary or if flexibility is desirable where the Trust will hold a property for the vulnerable child to live in but if that the property is sold flexibility is desired for the distribution of the sale proceeds.

The downside is taxation, which is explored below, however the impact of this tax regime is lessened in lower value Trusts.

Discretionary Trust – taxation

Whilst a Discretionary Trust is very useful, particularly when considering multiple beneficiaries, the tax treatment is not favourable and needs to be carefully considered.

• A lifetime gift into Trust is subject to Inheritance Tax if it exceeds the current Inheritance Tax (IHT) Nil Rate Band of £325,000;
• There will be 10 yearly charges to IHT (and on exit of the Trust after 10 years) if the value in the Trust exceeds the current Nil Rate Band. The charge is a maximum of 6% of the value exceeding the Nil Rate Band;
• Capital Gains Tax would currently be charged on any gains incurred on the Trust assets at 24% after deducting the Trustees annual allowance; and
• Income Tax would currently be charged on income arising on the Trust assets at a rate of 45% or 39.35% on dividend income.
• Any new Discretionary Trust created has to be registered with HM Revenue & Customs, within 90 days of being signed even if there is no tax due. 

Setting up a Discretionary Trust

A Discretionary Trust can be set up under the terms of your Will, or by a separate Trust Deed.

Trusts made in your lifetime are known as ‘Lifetime Trusts’, whereas Trusts set out in your Will are called ‘Will Trusts’. Lifetime Trusts come into effect when signed and may become active during your lifetime. Will Trusts come into effect on your death.

There are a number of reasons why it is a good idea to set up a Lifetime Trust, but this will depend on your personal circumstances.

Letter of Wishes

The Trust is supported by a Letter of Wishes, which explains why you have set up the Trust and how you would like the fund to be used.

The Letter does not form part of the Will or Trust document, but is kept with it to guide the Trustees. It can also explain how any remaining assets should pass to other beneficiaries after the death of the disabled or vulnerable beneficiary. As your wishes and your child’s needs may change, it should be reviewed regularly, ideally once a year.

Whilst there is a lot to consider, we are here to help. We can discuss your specific circumstances and advise on which Trist will be best suit you and your family’s circumstances.

We also run a programme of free webinars on the subject of Decision Making and Planning for the Future. Learn more about these events and register here.

Please do not hesitate to contact us to discuss your specific circumstances in more detail.