What is Discretionary Trust Tax in the United Kingdom?

What is Discretionary Trust Tax in the United Kingdom?

When someone dies, their beneficiaries are required to pay tax on their inheritance if the value of the deceased’s estate is over HMRC’s nil rate band threshold, which currently stands at £325,000. However, it is possible to lessen the tax burden on your family through discretionary trusts. Let’s look at this in more detail.


What is a discretionary trust?

Essentially, a discretionary trust is where the appointed trustees have a list of potential beneficiaries and have the discretion to make decisions on who from that list benefits from the trust. The trustees also have the authority to decide how the payments are made, when they are made, how often and how much. This can take the form of a lump sum (capital), a regular income or a combination of these two. For example, a child may be receiving a regular income but when they reach a specific age, they are also entitled to receive a lump sum which they use to buy a property.


How is a discretionary trust different from other trusts?

Any trust is a legal entity and as such, owns the assets (including property) held within the trust. However discretionary trusts are more flexible and put more ‘trust’ in the trustees to make the right decision, i.e., they have more power to decide how the income from a trust is used. In addition, it is often found that assets within a discretionary trust are more protected, such as from a creditor. However, the more detailed the guidance for trustees, the more likely your wishes will be adhered to.


The beneficiaries of a discretionary trust can be:


  • Named people;
  • Groups of people, such as ‘my children and their children (grandchildren)’;
  • Charity, one or more;
  • Organisations other than charities, such as the local sports club.


You can also provide for people who haven’t been born yet, such as the children of your own children, which allows you to provide for them in the future. Whilst a trustee can be a beneficiary, it is wise to choose an alternative person to avoid a conflict of interest.

They are useful in circumstances where the beneficiary may be unable to provide for themselves, such as a disability or an illness, those under the influence of others or substances, and any children under the age of 18 or 21 years. A discretionary trust can also be useful to protect assets from creditors and have been used in divorce proceedings.

As they are more flexible, they can be tailored to your specific requirements and cater for your needs as well as that of your family, favourite charities or organisations, and indeed anybody else you wish to be a beneficiary.

According to your detailed guidance, the trustees are able to make any changes to the trust, if appropriate, and if a beneficiary’s circumstances change they are able to make the necessary adjustments.


The tax implications of a discretionary trust


The use of discretionary trusts to alleviate the tax burden on your estate is becoming more popular. They can ensure that your family is not left with a significantly high inheritance tax bill to pay. In addition, if they are receiving any form of state benefit, such as a disability allowance or help with the fees for a care home, this will not be affected because of their inheritance.


If you are planning on leaving property to a beneficiary, a discretionary trust can help by allowing:


  • You or your beneficiaries, such as your spouse, have the opportunity to receive inheritance tax relief on business or agriculture.
  • Your assets that are expected to increase in value, and thereby subject to more tax, to be owned by your living spouse.
  • You split the family home between your living spouse and the trust, thereby discounting the taxable value of the property.
  • Your beneficiaries receive additional inheritance tax allowances if either you and/or your spouse have been widowed in the past.


If the value of the trust is below the £325,000 inheritance tax threshold, there will be no tax to pay. However, any value above this threshold is subject to tax. That said, with a discretionary trust, the trustees are expected to pay tax on the dividends they pay out to the beneficiaries from the trust, i.e. the income, which is set at 45%.

However, if a beneficiary is paying tax at a lower rate, i.e. they are on a low income or on DWP benefits, they may be entitled to claim back a proportion or all of that tax, depending on how much tax they are already paying to HMRC. One point to note is that if you pay tax on a self-assessment basis, the repayment of any dividend tax is calculated as part of your annual return.


Disadvantages of a discretionary trust


A discretionary trust can offer multiple advantages, as described above, however there are also disadvantages:

  • Expensive to establish – any trust is expensive to set up, maintain and also re-structure if necessary and a discretionary trust is no different.
  • Trust in the trustees – with a family or discretionary trust, the people you appoint as trustees take on the responsibility of becoming the legal owners of your assets, as well as any debts apportioned to the trust. With a discretionary trust, you are placing even more control into the hands of the trustees so it is important that you are able to trust them completely to make the right decisions.
  • Growth and profits – if a business is held within a trust, it can be harder to invest in and grow that business, plus trusts are not designed to retain any profits made. Therefore, in most cases, any profit will be passed onto the beneficiaries otherwise it is likely that the trust’s assets will be taxed.

At Norfolk Will Writing, we have been helping our clients write their wills for over 20 years. We also help with trusts, living wills, inheritance tax planning, LPAs and probate. We offer a personalised service, keeping the process as simple and easy as possible. Our experienced consultants are on hand to guide you through making your will as well as understanding and advising on the best way to manage your estate. Contact us for your free consultation and to book an appointment with one of our consultants to discuss writing your will today.

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