Using a Discretionary Trust to Manage Your Estate
A discretionary trust can be an invaluable asset when it comes to succession planning, as it enables clients to provide for children or others in need of financial assistance without incurring an immediate inheritance tax charge.
With a discretionary trust, there are no designated beneficiaries; rather, trustees choose from among a predetermined list of people or registered charities to whom income may be distributed at their discretion. Distributions often incur a 45% tax credit, leading to repayments from beneficiaries themselves.
Discretionary Will Trusts
Discretionary trusts are becoming a more and more popular way of minimising inheritance tax, but should not be seen as a means to entirely avoid it. Like all trusts, discretionary trusts incur costs such as set-up fees and ongoing administration expenses; nonetheless they can be highly effective tools in managing your estate efficiently. Dispensary trusts allow trustees to have complete discretion over when and how funds are dispersed to beneficiaries, including having the power to exclude assets from a beneficiary’s estate and thus making gifts that wouldn’t otherwise incur inheritance tax liability.
These trusts are particularly advantageous for clients wishing to provide for vulnerable family members, such as children at risk. Clients may worry that an inheritance could be wasted through drinking or drug use; those with younger children often wish for substantial sums to wait until later when their children have gained maturity and established careers before receiving substantial amounts. Discretionary trusts allow trustees to wait and see what their children require when they reach adulthood – perfect for planning these types of arrangements!
Inheritance tax can be a hefty financial strain for families, particularly those with larger estates. A discretionary trust may help alleviate this issue by enabling you to gift away portions of your estate that will not incur inheritance tax; increasing the total value that remains exempt. If you are considering creating a discretionary trust, it is wise to seek expert advice as there are certain rules and regulations you must abide by in order to set it up correctly. Any gifts made within seven years of death will be counted towards IHT calculations as part of your Nil Rate Band (NRB).
Note that discretionary trusts do not qualify for Business Asset Disposal Relief and you should also evaluate whether they qualify for Residence Nil Rate Band (RNRB) relief if using one to transfer property.
Discretionary Trusts for Inheritance Tax
Discretionary trusts can be an effective tool to reduce inheritance tax (IHT) liabilities and assist with planning for vulnerable beneficiaries, especially children with special needs or disabilities. Parents frequently want their child or beneficiary to gain substantial financial benefits later in life and this type of trust allows this in an organised yet flexible manner compared to receiving funds directly into their estates.
Trustee control over when and to whom funds from this type of trust is fully discretionary. Furthermore, due to assets held within it not being included as IHT allowance for beneficiaries on death, they won’t incur inheritance tax charges at 40% rate on death – plus any charges on trustees and their siblings!
Income earned by beneficiaries of discretionary trusts will typically be taxed at their marginal tax rate; however, when funds designated solely for discharging qualifying expenses related to disability or chronic illness is received this income will be exempt from inheritance tax (IHT).
Maintenance of a discretionary trust can impose an administrative burden, with trustees required to hold meetings, complete annual accounts and file tax returns. Furthermore, it’s crucial that they seek expert legal, accountancy and financial advice as soon as possible.
Historically, discretionary trusts were frequently employed to ensure both spouses could take full advantage of their respective IHT nil rate bands on death. Now that nil rate bands may be transferred upon marriage or civil partnership death, this type of planning is no longer necessary.
Within two years of death, distributions from a discretionary trust are exempt from exit charges under any relevant property regime, since trustees can distribute those assets that they consider are more valuable than their original cost. However, capital gains tax remains applicable; instead, beneficiaries can opt to defer their gain until either disposing of it themselves or dying.
