What you need to know about discretionary trusts
Author: Hannah Miles
Key contact: Janice Powell
In this article, we explain the hidden dangers of discretionary trusts in straightforward, practical terms.
When it comes to protecting family wealth or planning for the future, many people turn to discretionary trusts. These trusts are often recommended as a way to safeguard assets, manage inheritances, or provide for loved ones in a flexible way.
But while discretionary trusts can be very effective in the right situations, they aren’t without risk. In fact, they can sometimes cause unexpected problems for families – and it’s important to understand the potential pitfalls before deciding whether one is right for you.
What is a discretionary trust?
A discretionary trust is a legal arrangement where assets such as property, money or investments are held by trustees for a group of people called beneficiaries. What makes a discretionary trust different is that the trustees have complete control over if, when, and how much each beneficiary receives.
The person making the trust is known as the settlor. The settlor can write a letter of wishes to guide the trustees but, ultimately, they decide how to manage and distribute the trust’s assets.
What are the risks of a discretionary trust?
You lose control over your assets
Once assets go into a discretionary trust, the settlor will no longer own or directly control them. Although the settlor can express their preferences, trustees have the final say – and they are not legally required to follow a letter of wishes. This means the settlor’s intentions might not always be carried out in the way they’d hoped.
Trustees hold significant power
The trustees have the authority to make decisions about who benefits from the trust and when. If the wrong trustees are chosen, or if disagreements arise, this can lead to poor decisions, financial losses or unfair treatment of certain beneficiaries. It’s essential to appoint trustworthy, capable people or professionals.
Potential for family disputes
Because beneficiaries don’t have an automatic right to anything from the trust, decisions about who gets what – and when – can sometimes cause friction between family members. Disagreements about fairness or perceived favouritism can damage relationships and, in some cases, lead to costly legal disputes.
Complicated and expensive tax rules
Discretionary trusts often face higher tax rates than other types of trust or direct inheritance. In the UK, income generated by the trust is taxed at a higher rate, and there can be inheritance tax charges when money leaves the trust or every ten years while it remains in place. Without careful tax planning, these charges can significantly reduce the value of the trust over time.
Changing laws and regulations
The rules governing trusts, particularly around tax and reporting requirements, change regularly. In recent years, new regulations have required most trusts to register with HMRC, and there is increasing scrutiny of how trusts are used. What works well now might not be as beneficial in future.
Uncertainty for beneficiaries
Because discretionary beneficiaries don’t have a guaranteed entitlement, they can’t rely on the trust as a definite source of financial support. This can make it difficult for them to plan for major life events like buying a home, paying for education or managing day-to-day finances.
Is a discretionary trust still a good idea?
Discretionary trusts still have a valuable role to play in estate and wealth planning, particularly if:
- You want to protect assets for future generations
- A beneficiary is too young or financially vulnerable
- You need to provide for a disabled or vulnerable family member
- You wish to shield assets from divorce, creditors or financial risks.
However, they are not a one-size-fits-all solution. The risks and responsibilities involved mean they must be set up with care and fully understood by everyone involved.
How to protect yourself and your family
If you’re thinking about setting up a discretionary trust, or you already have one in place, here are some practical steps you can take:
- Take expert legal and financial advice before making any decisions
- Choose trustees carefully – ideally experienced professionals or responsible individuals you trust completely
- Update your letter of wishes regularly to reflect changing circumstances
- Review the trust arrangements periodically to ensure they still meet your needs
- Understand the tax consequences fully and plan accordingly.
Speak to our trust specialists
If you’d like to discuss your situation, have an existing trust reviewed or need assistance obtaining money from a trust, our friendly, experienced Contentious Probate team is here to help. Contact us today.
