Discretionary Trust

What it is

A trust written into your Will under which nobody has a fixed entitlement. You name a class of potential beneficiaries, your trustees choose between them, and you leave a letter of wishes to guide them.

It is the most flexible tool available, which is exactly why it needs the most thought.

How it works

• No beneficiary has a right to income or capital. Nothing is anyone’s until the trustees decide it is.
• Your letter of wishes guides the trustees and should be considered by them, but it does not bind them. Beneficiaries can see the trust accounts. They are not entitled to see the letter of wishes.
• For Inheritance Tax this is a relevant property trust. Above the nil rate band there is a charge on each ten year anniversary of up to 6% of the excess, and a proportionate charge when capital leaves.
• There is no exit charge in the first three months, or within three months of a ten year anniversary.
• Trust income is taxed at the higher trust rates above a small starting band, and the trustees have half of an individual’s annual exemption for Capital Gains Tax.

Where specialist advice matters

• If the family home is left to a discretionary trust, the residence nil rate band is lost. The property is not closely inherited, and that is true even where the only potential beneficiaries are your own children and grandchildren. The allowance can be recovered if the trustees appoint the property out to a direct descendant within two years of death, but somebody has to know to do it, and to do it in time.
• Many of these trusts are set up holding no more than a nil rate band. It is often worth reviewing whether to wind one up before its first ten year anniversary.
• Adding property to an existing relevant property trust complicates every later calculation and is usually best avoided.
• The trust will normally need registering with HMRC, and kept current.