• Kylie Simmonds-Cox

The what, why and how of Discretionary Trusts

Trusts are very common and play a key role in many aspects of everyday life. Many people, often without realising it; will come into contact with a trust in one form or another at some point during their lives. Yet trusts are widely misunderstood and often seen as something just the wealthy need to be concerned with. Few structures are as widely used but as little understood as trusts, especially when it comes to the potential tax consequences which can arise when they are misused.

But trusts are particularly useful when planning how money and assets should pass from one generation to another, especially when family structures are complicated by divorces and second marriages. This; coupled with the growing frequency of marriage breakdowns, an ageing population and rising prosperity; makes trusts an excellent tool for long-term planning to ensure a family’s financial stability and security.

So what is a trust?

A trust is a legal relationship whereby a person (known as the Settlor) gives property to another (the trustee) to hold assets such as property, shares or cash (the trust fund) for the benefit of someone else or a group of people (the beneficiary or beneficiaries). The details are set out in a document (the Trust Instrument), which could be a Will or a Trust Deed. A Trust can take effect during the lifetime of the Settlor or shortly after the death of the Settlor.

When you place assets into a trust, then you are no longer the legal owner of these assets and they are instead legally controlled by the trustee. But whilst the trustee of a trust is the legal owner of the property within the trust, the trustee can only deal with the trust property for the benefit of the trust beneficiaries as detailed in the Trust Instrument.

In the Trust Instrument, you can have a say over how those assets are managed now and in the future. You have the power to set out who receives the income arising from the assets and when they receive it, as well as who receives the underlying capital represented by the assets themselves and when.

So what is a Discretionary Trust exactly?

Under a Discretionary Trust, a beneficiary has no absolute current right to benefit from the trust assets. The trustee has the discretion to distribute trust income (or the underlying assets in the trust, known as trust capital) to whichever beneficiaries they choose. Alternatively, they also have the discretion not to distribute anything at all.

But why might I need one?

Discretionary trusts are very flexible and can have many uses. For example you might not know how much your beneficiaries might need in the future, so you can leave that responsibility to the trustees. Another good use for a discretionary trust is a personal injury trust, which can be set up by, or on behalf of, someone who has received compensation from a personal injury claim so that they don’t lose eligibility for their benefits.

As a trust can last for up to 125 years, trusts are useful vehicles for facilitating succession planning. Once an asset is within a trust, that trust can span several generations, enabling each succeeding generation to benefit from the income of the trust, whilst protecting the underlying assets from the vagaries of "events", such as divorce, profligate children and bankruptcy.

Could I give my beneficiary an outright gift instead?

As you will have seen because a discretionary beneficiary does not have a fixed right to the trust assets, then in most cases, from an asset protection perspective, assets held in a discretionary trust cannot be attacked by creditors or claims so they are ideal for protecting assets from business or personal disputes. Divorce is an example of this, assets owned outright can be taken into account when financial provisions are made during a divorce settlement. Assets gifted to a beneficiary may therefore be lost or have to be shared with a former spouse.

In addition, a beneficiary may be in receipt of means-tested benefits, and those benefits could be reduced or stopped as a result of receiving an outright gift. They may also be unable to manage their affairs due to an illness or disability and so a trust is a way to provide for vulnerable loved ones who are unlikely to be able to look after their own affairs. Some beneficiaries can be easily influenced by family members or friends who may not always have their best intentions in mind. In addition, addictions such as drink, drugs or gambling can also lead to a beneficiary making unwise decisions in relation to their gift.

A trust allows you to provide for your spouse or partner whilst protecting the interests of any children. This can be particularly important for families where there are children from previous marriages and to protect your assets in the event of your spouse or partner meeting someone else. For example, if a beneficiary dies, an asset that has been given to them outright may pass by Will or by the Rules of Intestacy (where a person dies without a Will),

to their spouse who may go on to meet a new partner and remarry. On their death, this asset could then pass onto their new spouse or step-family, resulting in the asset ultimately

benefitting a completely different family. This can often be a concern when large gifts are made to married children.

A discretionary trust allows you to protect the inheritance of young children until they are old enough to take responsibility for their own affairs, whilst also ensuring that funds can be made available to cater to their needs during their upbringing, such as funding their education.

Flexibility and Confidentiality

A trust allows the settlor to indicate how they wish the trust fund to be used and who should benefit but can leave it to the trustees to decide over time who should benefit, when and how. The settlor can leave a letter of wishes for the trustees to express their wishes in further detail or leave the decisions to the trustees discretion. This type of trust also enables people to benefit, who are not even born yet – such as future grandchildren.

Trusts are personal arrangements, laying out how a family’s assets are to be distributed within the family and many people would expect such arrangement to be kept confidential. The general public has limited or no access to information on family trusts, this information is retained by the trustees and only disclosed to beneficiaries in certain circumstances.

Tax Consequences

It is important to understand that Different types of trust are subject to Income Tax, Capital Gains Tax and Inheritance Tax in different ways. The rates and allowances vary according to the type of trust and how the beneficiaries stand to benefit from it.

Further advice

If you have substantial personal and/or business assets and have never considered setting up a trust for the benefit of your family, there is plenty to be gained by talking to your Estate Planner about the pros and cons.

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