Trust at your discretion

Trust at your discretion

Discretionary trusts are often used as an important part of estate planning, but they have many advantages beyond the contents of your will

I’ve written before about how crucial it is from a financial, practical and emotional point of view to get your estate in order well ahead of time and that the pandemic served as a sober reminder that none of us know how long that time will be.

One of the best ways of protecting the fruits of your labour is to set up a trust and it’s rather ironic that while the dictionary definition of the word trust is the ‘firm belief in the character, ability, strength, or truth of someone or something people are often slightly sceptical about trusts as legal vehicles. Quite simply, they are a way of making sure that your assets are protected and safeguarded for your family and will be directed in exactly the way you wish them to be.

Reduce your IHT bill

There are several different types of trust, but discretionary trusts are often used to reduce the value of your estate as part of a wider inheritance tax (IHT) and estate planning strategy. They are a way of providing for beneficiaries without giving them the rights to the trust assets and, in the event of your death, they can give family and loved ones financial certainty. These trusts can be set up during your lifetime and can also be written into your Will (discretionary Will trust). When you place assets into a trust, you are no longer their owner (the trustee is). As long as the trust was set up after 2006 and provided you set it up at least seven years before you die, the assets are not part of your estate, and so will not be subject to the usual IHT rate of 40%. That is not to say that there is no tax to pay at all. Generally, with some exceptions, you pay 20% IHT if the assets are over the nil rate band of £325,000. There is also a periodic (every 10 years) charge for the trust. The maximum tax rate for these charges is 6% and is payable by the trustees (from the trust).

Stay in control

However, there are a huge number of advantages of setting up a discretionary trust including full control over your assets (especially if beneficiaries are young and maybe irresponsible), protection of assets from risks like divorce, and flexibility over the appointment of trustees and the nomination of beneficiaries. Beneficiaries can be named individuals, a class of people such as “my grandchildren”, a charity or other organisation. Under a discretionary trust, beneficiaries do not have any automatic right to receive the money and/or property held in the trust. Instead, the trustees will decide when to distribute assets or income out of the trust and how much a beneficiary will receive, if anything. If you own your own business a discretionary trust can provide a useful structure in which to pass on shares in a family business, thereby offering protection for the benefit of future generations.

Other tax considerations

There are three other taxes that interact with a discretionary tax. Regarding Capital Gains Tax,  discretionary trust is considered a separate entity and is liable to paying CGT on any gains above the trust’s annual allowance, which is half the allowance an individual benefits from. This is £12,300 for individuals and £6,150 for trusts in the 2021/22 tax year. For income tax, for the first £1,000 of income received by the trust, dividend income is taxed at 7.5% and all other types of income are taxed at 20%. Beyond this amount, dividend income is taxed at 38.1% and all other income is taxed at 45%. And discretionary trusts do not benefit from relief on stamp duty, even if the trust is a first time buyer. Instead, a discretionary trust will generally be liable at the higher rate of stamp duty.

Horses for courses

Setting up a discretionary trust is not the right answer for everyone, but it offers a real opportunity to be tax efficient, protect your assets and help your loved ones, so it’s worth considering. They are not expensive to set up but it is important to get professional help to ensure the trust, and the investment strategy within it, complies with all the rules.

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