Discretionary Trusts in Wills

September 2021

Information Discretionary Trusts in Wills

Introduction death. This was limited to 80 years in the case of wills signed on or before 5 April This information sheet sets out briefly for 2010. The testator will provide how any general guidance the main features of undistributed assets must devolve when the Discretionary Trusts in wills and their tax trust comes to an end. implications. A number of important and technical points arise. Specific advice Use of Discretionary Trusts should be obtained before such a trust is used in any particular case. Before the introduction of a transferable Inheritance Tax ('IHT') nil rate band What is a Discretionary Trust? between spouses, Discretionary Trusts were frequently incorporated in wills in order Discretionary Trusts are so called because to make use of the nil rate band available on no beneficiary has a fixed entitlement. The the first death. Such trusts are now less trustees, who are usually (but not always) likely to be used for that purpose, but can the same persons as the executors, have have advantages in certain situations. complete discretion to decide what, if any, Further details are available in our benefits should be given to each of the information sheets 'Inheritance Tax-Efficient

beneficiaries. The trustees are given powers Wills' and 'Nil Rate Band Discretionary of appointment which enable them to pay Trusts in Wills for Spouses or Civil capital and income to one or more Partners'. beneficiaries or to create new trusts for their benefit. The class of possible beneficiaries The main advantage of Discretionary Trusts can be as wide or narrow as the person is where flexibility is required. For example: making the will, known as the 'testator', chooses. Mere inclusion in the class does 1 the testator may not have decided who not confer any legal right to receive any should eventually take the assets or in benefit. The testator may give the trustees what proportions; power to nominate or to exclude beneficiaries. Not all of the beneficiaries 2 the testator may require flexibility in case need to be in existence when the will is he fails before death to review his will, in made, or when the trust takes effect on the the light of changing tax and personal death of the testator. circumstances, or becomes unable to do Head Office so; Heathervale House 2-4 Vale Avenue The trustees will normally be given power Tunbridge Wells not only to distribute income but, instead, to 3 the testator may not want his detailed Kent TN1 1DJ accumulate it as an addition to the capital of wishes regarding his estate to be of T 01892 510000 the trust. Historically, they have been public knowledge after his death. F 01892 540170 authorised to accumulate income only for up Thames Gateway to 21 years after the testator's death. Trusts may also be useful for asset Corinthian House However, this period was extended to the protection as far as the beneficiaries are Galleon Boulevard concerned. Crossways Business Park lifetime of the trust for wills signed after 5 Dartford April 2010. Kent DA2 6QE A Discretionary Trust will enable the T 01322 623700 testator's estate to be distributed in F 01322 623701 A Discretionary Trust may continue for up to 125 years from the date of the testator's accordance with his wishes, but with

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flexibility in doing so if circumstances mentioned below). The maximum rate of subsequently change, and in the most tax- IHT on each occasion is currently 6%. efficient way. Any 'related settlements' will have to be Flexibility is maintained by listing all the taken into account when calculating the ten- possible beneficiaries and allowing the year anniversary and exit charges. A trustees to decide who takes what, if related settlement is any other trust created anything, and when. by the will, except a trust in which a surviving spouse has an immediate interest There are also certain tax reasons why a in possession. Discretionary Trust may be recommended (see below). If the value of the trust assets at the date of death is within the testator's available nil The Trustees rate band (taking into account any chargeable gifts within the seven years In view of the very wide powers which a before death) and assuming that there are Discretionary Trust normally confers on the no related settlements, there will be no IHT trustees, it is vital to ensure that they can be on any capital distributions made before the relied upon to safeguard the trust assets tenth anniversary of the testator's death. and always to act in the best interests of the However, this may not be true where the beneficiaries. It is desirable for the testator assets which are settled qualify for either to write a letter of wishes providing the Business or Agricultural Property Relief at trustees with non-binding guidance as to the testator's death. how the testator would want them to act. It may also be sensible to appoint one or It will normally be sensible to consider more professional or other independent whether distributions should be made trustees, particularly if the intended trustees before the tenth anniversary, as the exit are also possible beneficiaries. charge is based on the initial value of the trust assets. In contrast, the IHT charge on Tax implications the tenth anniversary is based on the value of assets in the trust at that time. 1 IHT Special treatment applies where a capital A Discretionary Trust is not exempt from distribution is made, or the terms of the trust IHT, so there may be an IHT liability on the are altered, within two years after the testator's death, depending on the value of testator's death. This is not a chargeable the estate. event for IHT purposes, so there can be no exit charge. Instead, the testator is treated The trust assets will not be treated as for IHT purposes as having provided for the belonging to any of the beneficiaries for IHT distribution or alteration in the will. For purposes. There will be a potential charge example, if assets are distributed from the to IHT on the trust fund every ten years. trust to the testator's widow within two years There will also be an exit charge when of his death, the spouse exemption will distributions of capital are made (except apply to those assets and any IHT where the special treatment applies as previously paid can be recovered.

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2 Capital Gains Tax ('CGT') 3 Income Tax

The trustees will be liable to CGT currently Trustees of a Discretionary Trust generally at 20% (or at 28% on residential property) in have to pay Income Tax at 45%, except on respect of any gains since the testator's income within the £1,000 standard rate death exceeding the trustees' available band and, as mentioned below, on annual exemption, which is presently a dividends. The trustees are not eligible for maximum of one half of the individual’s any personal or dividend allowances, but annual exemption. can deduct certain expenses when calculating their tax liability. There will be no uplift in the base value of the trust assets for CGT purposes on the A beneficiary who receives a distribution of death of any beneficiary. income is given a credit for the 45% tax paid by the trustees. If the beneficiary is a non- Should any beneficiary become entitled taxpayer or taxpayer at the basic or higher outright to the trust assets, the trustees will rate, he/she may reclaim the surplus tax be treated as if they had disposed of them. previously paid. If the beneficiary is taxable Any CGT liability on such a disposal may be at the top 45% rate, he/she will have no deferred, irrespective of the nature of the further tax to pay. assets, by an election for hold-over relief (except as mentioned below). Trustees of Discretionary Trusts pay tax at a special rate of 38.1% on dividend income Where capital distributions are made within received. However, the trustees may have two years after the testator's death, the additional Income Tax to pay if they CGT position will have to be considered distribute dividend income and each case carefully. If the trustees exercise their must be looked at separately. A beneficiary powers before the trust receives the (other than a top rate taxpayer) receiving relevant assets, there is no disposal by the dividend income will still be able to recover trustees and the beneficiary is treated as some or all of the tax paid by the trustees. acquiring those assets at probate value from the testator's estate. However, if the Administration assets are no longer required for the administration of the estate and are vested A Discretionary Trust needs to be properly in the trustees before they exercise their administered. This usually involves the discretionary powers, the trustees are trustees filing annual Tax Returns and deemed to have acquired the trust assets at issuing appropriate tax deduction probate value. In that event, on a certificates to beneficiaries who have subsequent capital distribution out of the received income. The trustees should also trust, there will be a disposal by the trustees maintain trust accounts and properly for CGT purposes. Hold-over relief will not manage the trust's property or investments. be available if a distribution of non-business The amount of administrative work will assets is made before the second depend on the nature of the trust assets and anniversary of the testator's death. on the frequency or otherwise of distributions of income and capital.

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Conclusion We do not accept any responsibility for action which may be taken as a result of A Discretionary Will Trust may be suitable having read this information sheet. for a testator who wishes to leave assets for the future benefit of a number of potential NOTE: The law is stated as at 1 September beneficiaries, with maximum flexibility as to 2021. the manner in which the income and capital are distributed. If you require further information, please contact Mark Politz or Stuart Goodbody on A Discretionary Trust can be particularly 01892 510000 or by email at: attractive if the initial value falls below the testator's nil rate band for IHT. It should [email protected] also be noted that the Income Tax suffered by the trustees may be partly or wholly [email protected] recovered to the extent that income is distributed to beneficiaries who pay tax at * All references to the term 'spouse' include less than the trust rate. a civil partner as defined by Section 1 of the Civil Partnership Act 2004 Disclaimer

This information sheet is written as a

general guide. As any course of action must depend on your individual circumstances, you are strongly