Definition
A discretionary trust is a flexible trust arrangement where trustees have complete discretion to decide which beneficiaries receive trust assets, how much they receive, and when distributions are made.
Unlike other trusts where beneficiaries have fixed entitlements, discretionary trusts allow trustees to adapt distributions based on beneficiaries' changing needs and circumstances over time.
What Does Discretionary Trust Mean?
Under English trust law, a discretionary trust is a trust where the beneficiaries and their entitlements are not fixed, but are determined by criteria set out in the trust instrument by the settlor (the person creating the trust). The Trustee Act 2000 establishes that trustees have a statutory duty of care when exercising discretionary powers, while the Trustee Act 1925 Section 33 addresses protective trusts containing discretionary elements.
The trust involves three key parties: the settlor who creates it, the trustees who manage it, and the potential beneficiaries who may receive distributions. Potential beneficiaries are typically identified by class—such as "my children, grandchildren, and remoter issue"—rather than named individuals with fixed entitlements. Only when trustees exercise their discretion in someone's favour do they become actual beneficiaries receiving trust assets.
Discretionary trusts can be created in a will (taking effect on death) or during the settlor's lifetime by deed. For will trusts, James might create a discretionary trust for his second wife Catherine and his children Sophie and Thomas from his first marriage, with his estate worth £730,000. The trustees can provide Catherine with income during her lifetime while preserving capital for the children, or adjust distributions if circumstances change—such as Catherine remarrying a wealthy partner or needing care funding.
Trustees make distribution decisions based on beneficiaries' needs, circumstances, and the settlor's wishes expressed in a letter of wishes. This guidance document is not legally binding but trustees must consider it carefully. Margaret might leave £120,000 in discretionary trust for her son Daniel who struggles with gambling addiction. The trustees can provide regular living expenses, pay his rent directly to the landlord, and fund specific needs like counselling, without giving him access to lump sums that could trigger relapse.
The trust provides maximum flexibility for unpredictable situations. It's particularly valuable for blended families balancing competing interests, vulnerable beneficiaries who cannot manage money, preserving means-tested government benefits, multi-generational planning including future grandchildren, and protecting inheritance from divorce settlements or creditors. Trustees have legal authority to withhold distributions if they believe it's in beneficiaries' best interests, making discretionary trusts more protective than direct inheritance.
However, this flexibility comes with complex tax treatment. Discretionary will trusts don't pay inheritance tax on creation—IHT has already been paid on the estate. But they face 10-year anniversary charges of up to 6% on value above the nil-rate band (currently £325,000), plus exit charges when distributing capital. Trusts also pay 45% income tax on income over £500 (or 39.35% on dividends), and 24% capital gains tax on disposals. The two-year rule provides planning flexibility: distributions within two years of death are treated as if made directly by the deceased's will, potentially avoiding some charges.
Creating discretionary trusts requires professional advice from a solicitor specializing in trusts and estates, plus ongoing trustee management and tax compliance. The cost and complexity must be weighed against the protection and flexibility benefits for your specific family situation.
Common Questions
"When should I consider using a discretionary trust in my will instead of leaving money directly to my children?" Consider a discretionary trust if your children are young, financially unstable, or have special needs requiring managed support. It's also valuable for blended families where you want to balance your current spouse's needs with your children's eventual inheritance, or if beneficiaries receive means-tested government benefits that a lump-sum inheritance would jeopardize.
"Can trustees refuse to give money to a beneficiary even though they're named in the discretionary trust?" Yes, trustees have complete discretion and can refuse distributions if they believe it's not in the beneficiary's best interests or the trust's purposes. They might withhold funds from a beneficiary with serious gambling addiction, or delay distributions until a young beneficiary is more mature. However, trustees must act reasonably and in good faith according to their fiduciary duties under the Trustee Act 2000.
"How much tax do discretionary trusts pay and is it worth the cost?" Discretionary trusts created in a will don't pay inheritance tax on creation, but face potential 10-year anniversary charges of up to 6% on value above £325,000, plus exit charges when distributing capital. They also pay 45% income tax on income over £500 annually. Whether this cost is worthwhile depends on the protection and flexibility benefits for your specific family situation—professional advice is essential.
Common Misconceptions
Myth: Discretionary trusts are only for the very wealthy and aren't relevant to ordinary families.
Reality: While discretionary trusts were historically used by wealthy families, they're now valuable for estates above £325,000 facing blended family complexities, vulnerable beneficiaries, or means-tested benefit concerns. The flexibility they provide for managing complex family situations is often more important than tax savings, making them appropriate for many middle-class families navigating challenging circumstances.
Myth: Once I create a discretionary trust, the trustees can do whatever they want with my money and ignore my wishes.
Reality: Trustees have legal fiduciary duties requiring them to act in beneficiaries' best interests and follow the trust's purposes. While your letter of wishes isn't legally binding, trustees must give it serious consideration and can be held accountable if they act unreasonably. Courts can remove trustees who abuse their discretion or fail in their statutory duties under the Trustee Act 2000.
Related Terms
Understanding Discretionary Trust connects to these related concepts:
- Trust: Discretionary trust is a specific type of trust, the broader legal arrangement where assets are held by trustees for beneficiaries.
- Trustee: Trustees are the individuals or organizations who manage discretionary trusts and exercise the discretionary powers central to this trust type.
- Beneficiary: In discretionary trusts, beneficiaries are "potential" beneficiaries who only become "actual" beneficiaries when trustees exercise discretion in their favour.
- Life Interest Trust: This contrasting trust type gives one beneficiary fixed rights to income, offering less flexibility but different tax treatment than discretionary trusts.
- Settlor: The settlor creates the discretionary trust and determines its purposes and potential beneficiaries, though they give up control once the trust is established.
Related Articles
- Understanding Trusts in Your Will: Explains how discretionary trusts fit into broader estate planning strategies and when they're the optimal choice.
- Estate Planning for Blended Families: Shows how discretionary trusts solve specific inheritance challenges in second marriage and blended family contexts.
- Protecting Vulnerable Beneficiaries: Demonstrates practical applications of discretionary trusts for beneficiaries who cannot manage lump-sum inheritances.
- Understanding Trust Taxation in the UK: Provides comprehensive explanation of how discretionary trusts are taxed and when the tax cost is justified.
Need Help with Your Will?
Understanding discretionary trusts is essential for complex estate planning, but implementing them requires expert guidance. If you're navigating blended family situations, protecting vulnerable beneficiaries, or planning for multi-generational wealth transfer, professional advice ensures you choose the right trust structure for your circumstances.
Create your will with confidence using WUHLD's guided platform. For just £99.99, you'll get your complete, legally binding will plus three expert guides. Preview your will free before paying anything—no credit card required.
Legal Disclaimer: This glossary entry provides general information about UK legal terminology and does not constitute legal advice. Discretionary trusts involve complex legal and tax considerations that depend on your individual circumstances and the trust's specific provisions. Tax rules are subject to change. You should obtain professional advice from a qualified solicitor and tax adviser before deciding whether a discretionary trust is appropriate for your estate planning. For advice specific to your situation, consult a qualified solicitor.