The advantages of discretionary trust wills

What is a Discretionary Trust Will?

A discretionary trust will is a flexible way of setting out how an estate should be managed and distributed. The will allows funds in the estate to be managed by appointed trustees who will decide which people become beneficiaries from a set list, and when and how they should receive their inheritance.

Essentially, with such a discretionary trust in your will, you leave your estate (or part of it) to ‘trustees’.  There must be at least two trustees appointed and you can choose who they should be. You decide on a list of potential beneficiaries which can include, if you wish, charities or people who are not yet born. The will allows trustees to use their discretion to decide which of those on the list become beneficiaries. This selection is completely at the trustees’ discretion. 

The funds in the estate will be managed by appointed trustees who will decide which people become beneficiaries from a set list and when and how they should receive their inheritance.

Essentially, with such a discretionary trust in your will, you leave your estate (or part of it) to ‘trustees’. There must be at least two trustees appointed and you can choose who they should be. You would then decide on a list of potential beneficiaries which can include, if you wish, charities or people who are not yet born. The trustees can use their discretion to decide which of the potential beneficiaries actually become beneficiaries. This is totally at the trustees’ discretion. 

Why would a discretionary trust will be used?

On the face of it, this type of will allows other people to choose how your estate is being distributed, but there are circumstances where this could be appropriate. For example:

• One of your intended beneficiaries may not be very good at handling his or her own finances and may welcome some assistance with looking after a significant amount of money.
• A beneficiary may have matrimonial or financial problems now or in the future. Although a discretionary trust does not guarantee that funds will be disregarded in any divorce proceedings, it would provide a means to defer an actual benefit until a beneficiary is in a more secure position.
• A beneficiary may be receiving means tested benefits and to receive an inheritance would result in benefits being reduced proportionately. A discretionary trust in this situation could be useful to enable the trustees to make ad hoc payments to such a beneficiary to improve their quality of life.
• It can sometimes be difficult to determine in advance an appropriate age for a beneficiary to come into an inheritance. Using a discretionary trust, allows trustees to look at the circumstances after death and decide when they think the beneficiaries are mature enough to receive money.
• Unmarried partners (or spouses or civil partners with different domiciles) may consider using discretionary trusts to ensure that their estates do not suffer an unexpected double inheritance tax charge which may result if such individuals just leave assets to each other outright.
• The beneficiaries may prefer not to inherit money directly because they are looking to limit the value of their own estate for inheritance tax planning purposes. In such circumstances it is common for beneficiaries to borrow funds from the trust as and when needed which can be on an interest free basis, instead of receiving a distribution.

How to set up a discretionary trust in your will

The discretionary trust is created by the terms of the will. This will also include a “list” of discretionary beneficiaries (i.e. named beneficiaries or charities) who have the potential to benefit from the trust.

It is very important that advice is sought from a suitable legal practitioner who is experienced in the drafting of wills and trusts to ensure that the trustees have the maximum flexibility to make payments out of the trust after your death. This would also involve making sure that adequate administrative provisions are included so the trustees can satisfy their duties and obligations easily.

Advantages of discretionary trust

A key advantage to a discretionary trust will is that your chosen trustees maintain control of your estate after you have passed away.

This ensures that intended beneficiaries benefit at a suitable time and allows the trustees to assess the circumstances of said beneficiaries at the time of any proposed distribution.

The trustees will also have the benefit of being able to assess the tax position at the time of your death to ensure any distributions are made in the most tax efficient manner.

The trustees may consider:

• providing smaller amounts of capital to a beneficiary in a controlled manner if they are frivolous with money or are in a position whereby, they are unable to manage large distributions of capital
• not to appoint funds out to a beneficiary until they are able to be able to manage such distributions
• appointing funds to a separate trust if the intended beneficiary is vulnerable and qualifies for a vulnerable beneficiary trust
• having discussions with the intended beneficiaries in respect of the values of their own estates, and if their estates are sophisticated and they do not require funds, whether it is more suitable and appropriate to benefit their children for instance, rather than them. 
• If all the discretionary beneficiaries are in a sensible position to inherit, the trustees may decide to appoint the funds out to all beneficiaries in accordance with your letter of wishes (discussed below) within two years, meaning that the trust is able to be wound up and the appointments that have been made are treated as if they had been made from the will itself.  

Disadvantages of discretionary trust

Trusts do require more onerous administration than a “straightforward” will. Naturally then, it can be a great responsibility for the chosen trustees. Weightmans offers advice in respect of administering a trust, or if preferred, can act as professional trustees.

Some of the general administrative steps include:

• registration with HMRC’s Trust Registration Service and keeping those records up to date.
• annual tax returns to report income and capital gains to HMRC and pay the tax due.
• regular trustee meetings to review the trust and the position of the beneficiaries. Minutes of said meetings should be drafted.
• drafting legal documents to confirm formally any decisions taken by the Trustees, particularly when making ‘appointments’ or payments to beneficiaries out of the trust. 
• Trustee duties and responsibilities are extensive, and great care should be taken to ensure that the trust is administered correctly as trustees can be held personally liable for misadministration. 

Letter of wishes

It is of course very important if a discretionary trust will is being prepared to leave a letter of wishes alongside it. Such a letter is not legally binding, but in it you can set out how you would expect the trustees to exercise their discretion and in what circumstances to benefit your beneficiaries. The trustees can take these wishes into account but are not bound by them. They must, however, always act in the best interests of the beneficiaries.

The letter of wishes might set out, for example, at what age minor beneficiaries should receive some money, and the circumstances in which trustees may be persuaded to make distributions before then, for example, for school or college/university fees or to purchase a house or a car.

Discretionary trust tax rates

The taxation of discretionary trusts is complex, and specialist advice should be sought.

Inheritance Tax

Discretionary Trusts can be subject to the following inheritance tax charges:

• A charge to Inheritance Tax on every 10-year anniversary of the creation of the trust. 
• An ‘exit’ charge on the distribution of funds out of the trust to beneficiaries between 10-year anniversary dates. 

Capital Gains Tax

•  Trustees have a reduced annual tax-free allowance and pay Capital Gains Tax at the highest rates.

Income Tax

• Trustees pay tax at special trust rates and there are complicated rules if trustees distribute income to beneficiaries. 
• From 6 April 2025 trusts with income of any kind up to £500 do not pay tax on that income as it arises. 
• The income tax rate for dividend income is 39.35%
• The income tax rate for all other income is 45%

How long can such a trust last?

Legally speaking, a discretionary trust could last up to a maximum of 125 years after your death. Very commonly, however, the trustees decide in a much shorter period of time how the trust fund should be distributed. For inheritance tax reasons, trustees should consider whether there are any appointments that they make within the first two years of death as such payments are treated as if they were included in the will itself.