Types of discretionary trusts

This article only considers UK inheritance tax and does not take into account other taxes or local rules.

What is a trust?

A trust is one way to move money out of your clients’ estates, perhaps to reduce potential liability to certain taxes. It can also avoid the potentially lengthy delays often associated with administering estates so that, in the event of a death, the people the deceased want to benefit from their estate do so as quickly as possible.

All manner of assets can be placed in a trust, including investments and life assurance policies.

Certain trusts not only allow your clients to pass on wealth when they die but can also give them access to regular withdrawals when alive. However, you should be aware that with trusts designed to achieve a tax saving, your clients usually have to forgo access to at least some of the original capital as well as any capital growth.

Types of trust

There are a number of different trusts but in their basic form they can be categorised as:

• absolute/bare or
• discretionary trusts

The main differences between the types of trust are the beneficial rights that the beneficiary may or may not have.

Absolute trust

With an absolute trust the beneficiaries are named and they have an absolute right to benefit under the trust – so much so that in England and Wales once an absolute beneficiary reaches age 18 they can demand that the trustees advance that beneficiary’s entitlement.

Discretionary trust

With a discretionary trust there are no named beneficiaries. Instead, there are predetermined lists of beneficiaries. These can be family members including spouses or civil partners, friends, registered charities and even companies. With a discretionary trust, the trustees have absolute discretion over who may benefit under the trust, so even if a beneficiary is within the class of beneficiaries there is no guarantee that they will benefit from the trust in any way.

For the rest of this article we'll consider discretionary trusts in more detail.

Uses of a trust

There are a number of reasons why a trust may be used. Some examples are:

• Tax planning
• Succession/generation planning
• Avoid probate
• Protection of asset 

Loss of control

One of the main concerns raised by clients when considering a trust is the loss of control, due to the fact that the trustees become the legal owners of the trust assets and the fact that sole discretion over the use of the trust property is with the trustees and not the settlor of the trust.

There are some practical solutions which may help to alleviate some of these concerns:

1. Choice of trustees
2. Use of a letter of wishes
3. Appointment of a protector

1. Choice of trustees

Consideration should be given as to whom to appoint as a trustee. It is possible to appoint a family member or a friend, but it is imperative that they understand their legal obligations and of course fulfil any reporting requirements. For these reasons, as well as financial planning considerations (eg if the trust is to be used for a number of generations), professional trustees may be considered.

2. Use of a letter of wishes

A letter of wishes is a document which the settlor provides to the trustees setting out their wishes. For example: ‘On my daughter obtaining age 21, I would like the trustees to consider advancing £100,000 to her’. A letter of wishes is not binding on the trustees but helps to provide some guidance of the settlor’s wishes. This is especially useful where a professional trustee is used. 

3. Appointment of a protector

It is also possible to appoint a protector. The term ‘protector’ is used to describe a person who is generally granted by a settlor (under the terms of a trust deed) some powers over the administration of a trust; such power to be exercised in addition to powers granted to the trustees. It is possible for the settlor to be appointed as the protector of the trust.

The protector does not have the same powers as a trustee and whilst the protector would not be involved in the day-to-day administration of the trust, they will have to fulfil certain duties and responsibilities.

For more information on appointing a protector please read our article The role of a protector.

Types of discretionary trusts available from Quilter

The following is a very high level overview of the types of discretionary trusts available through Quilter. For more information on these and other trusts available please contact your Quilter consultant.

Conclusion

There are various reasons why your client may wish to use a trust, and the purpose of this document is to provide a general overview of the variations of discretionary trust available and the access versus IHT efficiency trade-off. A key consideration for a settlor will be based on whether they wish to retain the right to withdrawals from their investment or whether they wish to gift away any of their capital.

It is common for settlors to use a combination of these options and to develop the planning as they progress through life and circumstances change.

Ultimately the objective is to minimise IHT on death but, perhaps more importantly, pass assets to the next generation via a trust rather than outright. All of these trusts will achieve the latter and the level of IHT efficiency depends on the option chosen. 

A by-product of the use of a trust may also be an element of asset protection. Consider a situation where the settlor declares a discretionary trust of say £1 million. A number of years later he is getting divorced and has been asked to state all his assets. The settlor does not declare the trust fund as this is no longer an asset he is the legal owner of.

It is very important that advice is sought before this planning is instigated as there are many other factors to consider.

All of the discretionary trusts described are subject to the UK relevant property regime and as such are potentially liable to tax not only on death but also during life. Entry charges, exit charges and periodic charges may all apply and must be considered with all of the planning. The order in which the trusts are created and the interaction with other gifts are very important and again advice should be sought.