Discretionary Trusts legal guide

Sun 8 October 2023

With a discretionary trust the trustees have the discretion to decide how and when to distribute the trust assets to the beneficiaries and the beneficiaries do not have an automatic right to the trust assets, and their entitlement can sometimes vary depending on the trustees' decisions. The objectives are often long term and with an emphasis on flexibility. The careful choice of trustees is hugely important in setting up any type of trust but even more so with a discretionary trust, where trustees will generally be given wide powers.

If you are considering a discretionary trust, either during your lifetime or as part of your will, experienced advice and careful planning are strongly recommended. Please note that a discretionary trust will rarely if ever be suitable if the main asset for the trust is your home. We have a number of trusts specialist lawyers, so please do get in contact to discuss how we can help.

Reasons for setting up a discretionary trust

We find that most clients who want to create a discretionary trust do so because of concerns about family issues. They are seeking to preserve value for beneficiaries and possible future generations. Reasons commonly include :-

Family business succession concerns - There is a family business and there are concerns about how beneficiaries would run the business. The availability of Business Property Relief (“BPR”) can often be factor as well but specific advice should be sought in relation to BPR aspects of discretionary trusts.
Concerns about financial irresponsibility - 1 or more of the beneficiaries has an unstable lifestyle, perhaps with addictions, mental health problems or a bad track record of dealing with money.
Providing for a beneficiary with a disability - 1 or more of the beneficiaries has disabilities which mean they need long term care and are perhaps unable to make decisions for themselves.
Protecting future generations - You specifically want to ensure that your legacy benefits grandchildren, whether these are living or not yet born.
Protecting capital - You may want to protect the capital value of your assets. The trust can provide that beneficiaries will only receive income under the trust, with income generation being the prime objective for the trustees to use their discretion to achieve.

Discretionary trusts can be expensive

Whilst it is possible to appoint 1 or more of the beneficiaries as your trustees, this can create significant friction and in many cases, clients who opt for a discretionary trust decide that the best and safest approach is to appoint professional trustees, such as lawyers or accountants.

This also has the benefit of high standards of decision making and professional accountability. With a long term discretionary trust, most professional trustees will charge an annual retainer, and this may be a relevant factor to consider, depending on the value of the trust fund.

Tax is almost always a prime consideration. Anti-avoidance legislation applies to family trusts where the settlor retains any interest in the assets and the assets will be included in the estate for Inheritance Tax (IHT) purposes. Family trusts are also charged tax of up to 6% of the value of the assets every 10 years and upon exit.

Family Investment Company - an alternative to a discretionary trust?

One of the most popular current alternatives is to create a Family Interest Company ("FIC"). Key things worth noting include :-

Control - FIC's provide a higher level of control over assets since family members can serve as directors and make decisions about the company's investments and distributions. This can be appealing if you want more say in how your assets are managed.
Flexibility - FIC's offer more flexibility in terms of managing assets and income. You can choose when and how to distribute dividends to shareholders, allowing for tax planning opportunities.
Transparency - FIC's are more transparent compared to trusts. The company's financial statements are publicly available, which can be advantageous for maintaining transparency within the family.
Tax Efficiency - FIC's can be tax-efficient, especially for business owners, as they allow for more control over the timing and nature of income distributions, potentially reducing tax liability. In general Family Investments Companies tend to be favourable where the investment is over the IHT nil rate threshold.

Solicitors for setting up and administering a discretionary trust

We have a team of very experienced trusts lawyers. Expertise includes :-

The planning stage, deciding whether a discretionary trust is the best option.
Setting up family investment companies.
Drafting discretionary trust deeds.
Advising on choice of trustees and any specific instructions and limitations on trustees discretion and powers.
Trust administration.