Using Discretionary Trusts as a Protective Tool in Your Will
10 minute read
Many families benefit from more than a simple will. This explains when a discretionary trust makes sense.
When most people think about making a will, they think about who they want to leave their assets to. But equally important is how those assets are left. For many families, simply naming a beneficiary and leaving them an outright gift is perfectly appropriate. For others, the circumstances of the people they love make a more considered approach necessary. A discretionary trust is one of the most versatile and powerful tools available in will drafting, precisely because it emphasises how assets are managed and distributed rather than merely who receives them. This guide explains what a discretionary trust is, how it works as a protective mechanism, when it is most valuable, and what its tax implications are.
Table of Contents
What Is a Discretionary Trust?
A discretionary trust is a legal arrangement in which assets are held by a group of trustees for the benefit of a defined class of potential beneficiaries. The defining characteristic of a discretionary trust is that the trustees have complete discretion over whether to make distributions from the trust, when to make them, to whom they are made, and in what amount.
No individual beneficiary has an automatic or fixed legal right to any part of the trust fund. Each beneficiary is simply a member of the class of people who might benefit, at the trustees’ discretion. The trustees hold and manage the assets and exercise their judgment on how best to apply them in accordance with the terms of the trust and the wishes of the person who created it.
This is fundamentally different from a bare trust or an outright gift, where the beneficiary has an absolute entitlement from the outset. In a discretionary trust, the beneficiary’s position is contingent. They may benefit generously or receive nothing, depending entirely on the trustees’ exercise of their discretion.
In the context of a Will, a discretionary trust is created when the testator directs that some or all of their estate should pass not directly to named individuals but into the trust, to be managed and distributed by the trustees according to the trust’s terms.
How a Discretionary Trust Works as a Protective Tool
The protective power of a discretionary trust flows directly from the absence of fixed entitlement. Because no beneficiary has an automatic right to the trust assets, those assets enjoy a degree of insulation from a range of threats that would otherwise put them at risk. This is the feature that makes discretionary trusts so valuable in so many different family situations.
Protection From Divorce Claims
In England and Wales, the courts have wide powers to redistribute assets between divorcing spouses in financial remedy proceedings. Inherited assets are not automatically exempt from this process. Where a beneficiary has received an inheritance outright, that inheritance sits in their name and may be treated as a resource in divorce proceedings, particularly if it has been mingled with matrimonial assets or if the other spouse has significant financial needs.
Where assets are held in a properly structured discretionary trust, the position is quite different. The beneficiary does not own the trust fund. They have no fixed entitlement to it. This makes it considerably harder for a divorcing spouse to argue that the trust assets should form part of the financial settlement. The trust fund belongs to the trustees, not the beneficiary, and that distinction can be legally significant.
Protection From Creditors and Bankruptcy
If a beneficiary is in financial difficulties, or becomes bankrupt, assets they own outright are available to their creditors. A trustee in bankruptcy can claim assets belonging to the bankrupt to satisfy the debts owed. An outright inheritance received at the wrong moment can be absorbed by creditors before it does the intended beneficiary any good at all.
Assets held in a discretionary trust belong to the trustees, not to the beneficiary. Because the beneficiary has no fixed entitlement to those assets, creditors generally have no direct claim on them. This provides significant protection in situations where a beneficiary is struggling with debt or insolvency.
Protection From Financial Immaturity and Exploitation
Not every risk to an inheritance comes from a court or a creditor. Sometimes the greatest risk comes from the beneficiary themselves, or from people around them. A young adult who inherits a substantial sum at eighteen may lack the experience to manage it wisely. An elderly beneficiary may be vulnerable to financial exploitation by people who seek to take advantage of their trust or confusion.
A discretionary trust addresses both of these risks by ensuring that assets are managed by responsible, chosen trustees rather than being handed over wholesale to the beneficiary. The trustees can make measured distributions that reflect the beneficiary’s actual needs and circumstances, rather than simply releasing a large sum that may be mismanaged or exploited.
Protection in Cases of Addiction or Poor Money Management
Where a beneficiary has an addiction, whether to alcohol, drugs, or gambling, or where they have a history of poor financial management, leaving them money outright is unlikely to be in their best interests, however well-intentioned. A large inheritance can destabilise someone who is in recovery, or disappear rapidly in the hands of someone who lacks financial discipline.
A discretionary trust allows the trustees to provide support in a structured and considered way, making distributions for specific purposes, paying for things directly on the beneficiary’s behalf, and withholding funds when the circumstances suggest that a distribution would cause more harm than good.
Discretionary Trusts for Vulnerable Beneficiaries
Discretionary trusts are particularly well-suited to situations where a beneficiary has specific vulnerabilities that make outright ownership of assets inappropriate or potentially harmful. Several distinct situations call for this kind of careful, trustee-managed approach.
Disability and Means-Tested Benefits
Where a beneficiary is disabled and relies on means-tested benefits or local authority care funding, an outright inheritance can cause serious practical problems. Benefits that are assessed on the basis of the recipient’s financial resources may be reduced or withdrawn entirely if that person suddenly acquires capital. The inheritance, intended as a gift, can end up costing the beneficiary the very support they depend on.
A discretionary trust avoids this problem because the beneficiary does not own the trust assets. As a potential beneficiary with no fixed entitlement, they do not hold capital in the way that triggers a means-test assessment. The trustees can use the trust fund to supplement the beneficiary’s care and quality of life without displacing the statutory support the beneficiary receives.
Where the beneficiary meets the legal definition of a disabled person under the relevant legislation, it may be possible to structure the trust as a qualifying disabled person’s trust, which attracts particularly favourable tax treatment. This is a specific and technical arrangement that requires careful drafting.
Our guide to providing for disabled beneficiaries explains in detail how trusts can be used to protect benefits entitlement and fund long-term care.
Addiction and Financial Recklessness
For a beneficiary with an addiction or a pattern of poor financial decision-making, a discretionary trust allows trustees to provide genuine support without the risks that come with handing over a lump sum. The trustees can pay for rent directly, fund treatment or rehabilitation, cover living expenses, and make measured distributions as the situation develops, without ever placing a large sum of money in the beneficiary’s hands.
Unstable Relationships
Where a beneficiary is in a marriage or relationship that appears unstable, or where there is concern that a current or future partner may exert undue influence over the beneficiary’s financial decisions, a discretionary trust provides a degree of insulation. The trust assets are not the beneficiary’s to give away or to allow a partner to access. The trustees retain control, and they can be guided by the testator’s letter of wishes to exercise particular caution where relationship-related risks are apparent.
The Power to Pay Expenses Directly
One of the most practically valuable features of a discretionary trust for vulnerable beneficiaries is the ability of trustees to pay for expenses directly, rather than handing cash to the individual. Rather than making a payment to the beneficiary, the trustees can pay rent directly to a landlord, pay school or university fees directly to the institution, fund medical or care costs directly with the provider, or cover utility bills and other household costs without the money passing through the beneficiary’s hands. This in-kind approach can make an enormous practical difference where the beneficiary’s vulnerability means that cash distributions would not achieve their intended purpose.
The Tax Advantages of a Discretionary Trust
Discretionary trusts can offer meaningful tax planning advantages, which are worth considering when deciding whether to include one in your will.
Inheritance Tax Planning Flexibility
When assets are left in a discretionary trust on death, the value of those assets is aggregated with the deceased’s estate for inheritance tax purposes in the usual way. However, the discretionary structure can offer planning flexibility in terms of how and when assets are distributed to beneficiaries after the trust is established, and it can allow the trustees to respond to changes in the tax position of individual beneficiaries over time.
In certain circumstances, a deed of variation executed within two years of the death can redirect assets into a discretionary trust in a way that is treated for inheritance tax purposes as if the trust had been created by the deceased. This can provide additional flexibility in estate planning even after the death has occurred.
Income Tax Efficiency
A discretionary trust can distribute income to beneficiaries in a tax-efficient way. If the beneficiaries include individuals who pay tax at lower rates than the trust rate, income distributed to them may be taxed more favourably than income retained within the trust. The trustees can exercise their discretion to allocate income in a way that reflects the relative tax positions of the beneficiaries, thereby producing a more efficient overall outcome.
Special Treatment for Disabled and Vulnerable Beneficiary Trusts
Where a discretionary trust is structured to qualify as a disabled person’s trust or a vulnerable beneficiary trust under the relevant legislation, it may attract significantly more favourable tax treatment than a standard discretionary trust. This includes relief from the ten-year periodic inheritance tax charge and exit charges, and the ability to elect for the trust’s income and gains to be taxed as if they belonged to the beneficiary directly. This is an important and potentially very valuable set of reliefs, but the qualification conditions are specific, and the drafting must be precise.
The Tax Disadvantages of a Discretionary Trust
A fair assessment of discretionary trusts requires an honest account of their tax disadvantages as well as their benefits. These are real costs that need to be weighed carefully in the context of each individual estate.
Higher Income Tax Rates Within the Trust
Income accumulated within a discretionary trust and not distributed to beneficiaries is taxed at the trust rate, which is currently 45% on non-dividend income and 39.39% on dividend income. These rates are significantly higher than the rates that apply to individuals, particularly those with modest incomes. The trust has a small standard rate band of £1,000, within which income is taxed at the basic rate, but beyond that, the trust rate applies in full.
Where trustees distribute income to beneficiaries, the income carries a tax credit at the trust rate, and beneficiaries may be able to reclaim some or all of the tax paid if their own personal tax rate is lower. But the administrative complexity of this process is worth bearing in mind.
Inheritance Tax Anniversary and Exit Charges
Unlike the bereaved minor’s trust and the disabled person’s trust, a standard discretionary trust is subject to two types of inheritance tax charge that do not apply to those more specialised arrangements.
The first is the ten-year periodic charge, sometimes called the anniversary charge. Every ten years, the trustees are required to calculate the value of the trust fund and pay inheritance tax at a rate of up to 6% of that value. Over a long-running trust, these charges can accumulate to a meaningful sum.
The second is the exit charge, which arises when assets are distributed out of the trust. The rate of the exit charge depends on when in the ten-year cycle the distribution is made, but it can represent an additional cost that reduces the value passing to beneficiaries.
These charges need to be factored into the overall assessment of whether a discretionary trust is the right structure, and they underline the importance of taking specialist tax advice as part of the will-drafting process.
Ongoing Reporting and Compliance Costs
Running a discretionary trust properly involves ongoing administrative obligations. The trustees are required to register the trust with HMRC’s Trust Registration Service, file annual trust tax returns where the trust has income or gains, keep proper accounts and records, and take professional advice on a range of decisions. These obligations involve time and cost, and they should not be underestimated. For smaller estates, the compliance burden may outweigh the trust structure’s protective benefits. This is a practical consideration that a specialist adviser can help you think through.
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Why the Choice of Trustees Is Critical
A discretionary trust is only as effective as the trustees who run it. The trustees have wide and largely unsupervised powers. They make the decisions. They control the money. Over the course of what may be a trust lasting many decades, the quality of their judgment, the consistency of their values, and the robustness of their character will determine whether the trust achieves its purpose.
Choosing the right trustees is therefore one of the most consequential decisions in any will that includes a discretionary trust.
Financial Competence and Independence
Trustees should have sufficient financial competence to manage the trust fund prudently, keep proper records, obtain appropriate professional advice, and fulfil the trust’s tax and reporting obligations. They do not need to be experts in every relevant field, but they should be sufficiently capable to understand what they are doing and to seek guidance when unsure.
Independence is equally important. The trustees should be people who can make decisions on the merits, free from the influence of any particular beneficiary or family faction. A trustee who is too closely aligned with one beneficiary may struggle to balance the interests of the beneficiary class fairly, or may find it difficult to withhold distributions even when doing so is clearly in the beneficiary’s long-term interests.
Avoiding Conflicted or Pressured Trustees
Family members who are emotionally close to the beneficiary may find the trustee role genuinely difficult. The pressure to say yes when a beneficiary is in distress, or to release funds when a family member applies persistent pressure, can be very hard to resist. A trustee who yields to that pressure in circumstances where a distribution would not serve the beneficiary’s real interests is failing in their duty, however understandable their motivation.
For this reason, it is often advisable to appoint a professional co-trustee alongside any family trustees. A solicitor, accountant, or specialist trust company brings independence, objectivity, and professional accountability to the role. They are equipped to resist pressure, to document decision-making properly, and to maintain the discipline that the trust requires over the long term.
It is also important to include provisions for the appointment of replacement trustees in the will, so that the trust can continue to function effectively if a trustee dies, loses capacity, or is no longer able to act.
The Letter of Wishes
A discretionary trust gives trustees broad powers, but it does not tell them how you want those powers to be exercised. That is the role of the letter of wishes.
A letter of wishes is a personal document, written by you and addressed to your trustees, that sits alongside your will. It is not legally binding, and the trustees are not obliged to follow it. But in practice, a thoughtful and detailed letter of wishes is one of the most valuable things you can leave behind, because it gives the trustees the context and guidance they need to make good decisions in your spirit, not just within the legal framework of the trust.
What a Letter of Wishes Should Cover
In the context of a discretionary trust, a letter of wishes might address several important areas.
It should explain the reasons behind the discretionary structure and what you were trying to achieve by including it in your will. Trustees who understand why a trust was created are much better placed to administer it in keeping with the testator’s intentions.
It should set out your priorities for each beneficiary, including any concerns you have about their circumstances, vulnerabilities, and how the trust fund should be applied for their benefit.
It should give guidance on your distribution philosophy, for example, whether you would like the trustees to prioritise income over capital, whether you would like them to make regular payments or to retain funds for specific purposes, and whether there are circumstances in which you would want them to exercise particular caution or particular generosity.
It should also address any family dynamics the trustees should be aware of, including relationships between beneficiaries, any individuals who might seek to influence the trustees, and any concerns about exploitation or pressure.
Balancing Protection With Quality of Life
A well-written letter of wishes does not simply tell the trustees to be restrictive. It asks them to balance the trust’s protective purpose with the beneficiary’s genuine quality of life. The trust fund is there to help the people you love, and a letter of wishes that reflects both your protective intentions and your wish for the beneficiaries to live well and flourish gives the trustees a much richer and more useful guide than one that simply emphasises caution.
Updating the letter of wishes periodically, as circumstances change, is also worth considering. Unlike the will itself, a letter of wishes can be revised without formality, and keeping it current ensures that it remains relevant and useful to the trustees for the duration of the trust.
How We Can Help
At Wise Owl Wills, we have extensive experience in drafting wills that include carefully considered discretionary trust provisions. Whether the purpose is to protect assets from future divorce, to provide for a vulnerable or disabled beneficiary, to safeguard an inheritance from creditors, or simply to ensure that what you leave behind is managed wisely over the long term, we understand both the legal tools available and the human circumstances that make them necessary.
We take the time to understand your family’s specific situation before we advise, and we draft every provision with the precision and care that trust law demands. We can also help you prepare a letter of wishes that clearly communicates your intentions and provides your trustees with the guidance they need to carry them out effectively.
A discretionary trust is not the right answer for every estate, and we will always tell you honestly if a simpler structure would serve your purposes just as well. We will always give you the information you need to make a well-informed decision.
Please contact us today to arrange a convenient time to speak with one of our team. There is no obligation, and all enquiries are handled with complete confidentiality.
Frequently Asked Questions
What is a discretionary trust in a will?
A discretionary trust in a will is an arrangement under which assets are left to a group of trustees rather than directly to named beneficiaries. The trustees hold and manage the assets and have the discretion to decide whether to make distributions, when to make them, to whom, and in what amount. No beneficiary has an automatic legal right to any part of the fund.
How does a discretionary trust protect beneficiaries?
Because no beneficiary has a fixed entitlement to the trust assets, those assets are generally better shielded from a range of threats than an outright gift would be. A discretionary trust can provide protection from divorce claims, creditors, bankruptcy, financial exploitation, and the risks associated with addiction or poor money management. The trustees retain control and can make measured, purposeful distributions rather than handing over funds in a way that might cause harm.
Can a discretionary trust protect assets from divorce?
A properly structured discretionary trust can significantly reduce the risk that trust assets will be drawn into divorce proceedings. Because the beneficiary has no fixed entitlement to the trust fund, there is no clearly defined asset in their name for a divorcing spouse to seek to include in a financial settlement. Courts have wide powers and can look behind trust structures in some circumstances, but a well-drafted and properly administered discretionary trust is considerably harder to attack than an outright inheritance.
What are the tax disadvantages of a discretionary trust?
A standard discretionary trust is subject to a ten-year periodic inheritance tax charge of up to 6% of the trust fund value, as well as exit charges when assets are distributed. Income accumulated within the trust is taxed at the trust rate of 45%, which is higher than the rate that applies to most individual taxpayers. The trust also has ongoing administrative and compliance obligations, including registration with HMRC and the filing of annual tax returns, which involve cost and management time.
What is the difference between a discretionary trust and a bereaved minor's trust?
A bereaved minor’s trust is a specific type of trust that arises when a child under eighteen inherits from a deceased parent. The child must become absolutely entitled to the assets at eighteen, and the trust benefits from exemption from periodic and exit inheritance tax charges. A discretionary trust has no fixed end date, no automatic entitlement for any beneficiary, and is subject to periodic and exit charges. A discretionary trust offers greater long-term flexibility and protection but involves a more complex tax treatment.
Who should I appoint as trustee of a discretionary trust?
Trustees should be financially competent, independent, and capable of making difficult decisions in the long-term interests of the beneficiaries without being unduly influenced by pressure from individuals connected to the trust. A professional co-trustee, such as a solicitor or specialist trust company, is often advisable alongside any family trustees, particularly where the trust is long-running or the beneficiary’s circumstances are complex.
What is a letter of wishes for a discretionary trust?
A letter of wishes is a personal document addressed to your trustees that explains your intentions, concerns, and priorities regarding the trust. It is not legally binding, but it gives trustees invaluable guidance on how you would like the trust to be administered. A well-written letter of wishes helps trustees to balance the protective purpose of the trust with the beneficiaries’ genuine quality of life, and it is one of the most useful things you can leave alongside a will that includes a discretionary trust.
Are discretionary trusts suitable for all estates?
Not necessarily. Discretionary trusts involve administrative complexity, ongoing costs, and a more demanding tax treatment than a straightforward gift. For smaller estates or beneficiaries with no particular vulnerabilities, a simpler arrangement may serve just as well. The decision whether to include a discretionary trust should always be based on a careful assessment of the specific circumstances, which is why taking specialist advice is important.
Disclaimer
This article is intended as general information only and does not constitute legal advice. The information refers to the law of England and Wales. Tax thresholds and legal rules are correct at the time of writing but are subject to change. We recommend that you seek professional advice regarding your own circumstances.
Bio
This article was written by Stephen Rhodes. Stephen was called to the Bar of England and Wales in 1999 and brings over 25 years of in-house experience working with solicitor firms across the Manchester area, with a specialism in Wills and Probate. He now focuses exclusively on will drafting, helping his clients ensure their loved ones are taken care of exactly as they would wish.