When it comes to estate planning, many people are familiar with the idea of trusts, they are a way of managing wealth for you, your family and anyone else you may wish to benefit.

There are a number of different types of trust, one of the most flexible options being a discretionary trust.

A discretionary trust can be a useful way to protect assets and give trustees flexibility over how and when assets are distributed to beneficiaries. No beneficiary has an automatic right to the assets, instead the trustees decide who should benefit, when payments should be made and how much should be distributed. The trust can hold cash, property, investments or other assets.

The flexibility makes discretionary trusts a valuable estate planning tool, particularly where family circumstances may change over time, or where the person creating the trust wants protections as well as control.

There are three main roles that sit at the centre of any discretionary trust. The settlor is the person who creates and places assets into the trust. The trustees become the legal owners of those assets and are responsible for managing them and making decisions about distributions. They are responsible for managing the trust in line with the trust deed, the law and any letter of wishes that the settlor may have prepared. The beneficiaries are the people, or classes of people, who may benefit from the trust. Because the beneficiaries do not have fixed entitlements, the trustees have the discretion to decide how and when to distribute income, appoint capital, or retain assets within the trust for future needs.

Discretionary trusts are often used when certainty is impossible or undesirable. Some examples for setting up a discretionary trust include:

– A parent or grandparent may want to benefit children or grandchildren but may not know in advance who will need support the most.

– If a beneficiary is vulnerable or lacks capacity and is receiving means tested benefits, a discretionary trust can mean that they are financially supported without their entitlement to assistance being affected.

– To manage complex family dynamics and preserve flexibility.

– You own and run a business and want to ensure that shares are passed down to future generations in a way that can be controlled by trustees.

– Assets held in trust are generally protected from risks that may affect a beneficiary personally such as bankruptcy, claims from creditors, ill health or even in the event of divorce proceedings.

The main advantages of a discretionary trust are:

– Flexibility: trustees are able to adapt distributions to reflect a change in a beneficiary’s needs, financial circumstances, relationships and health.

– Control: the trust can set a framework for how assets should be managed.

– Protection: beneficiaries do not own the assets; this may help shield funds from poor financial decisions or third-party claims.

– Long-term planning: the trust can support several generations.

– Tailored support: trustees are able to distribute more to beneficiaries in need and perhaps less to those who are financially secure.

However, discretionary trusts are not a simple, one size fits all solution. They may not be straightforward to establish and administer, and the role of trustee can be demanding. The success of the arrangement depends largely on choosing the correct trustees, those who are competent, impartial and able to work together.

When setting up a discretionary trust, it is also important to take into account the tax considerations.

Broadly speaking, assets placed into a discretionary trust may fall outside of the settlor’s estate for inheritance tax if the settlor survives seven years after the transfer, but this does not mean the trust is tax free.

Under UK rules, transfers into a discretionary trust are generally treated as chargeable lifetime transfers for inheritance tax purposes rather than outright gifts. Depending on the value transferred, and any previous transfers made by the settlor, there may be an immediate inheritance tax charge of 20% on amounts above the available nil rate band. Discretionary trusts are also subject to ongoing 10-year anniversary charges and exit charges on any assets distributed out of the trust. Any potential tax charge depends on the value of the trust and the nil rate band available at the time of the anniversary or exit.

Further, income retained in a discretionary trust is taxed at trust rates (39.35% on any dividend income and 45% on all other income). However, if income is distributed to a beneficiary, they may be able to claim a tax credit.

Capital Gains Tax also needs to be considered, trustees have an annual exemption that can be used, at the rate applicable to trusts, currently £1,500, they also pay any CGT due at the higher rate.

To set up a discretionary trust you will need a well drafted trust deed that clearly sets out the terms of the trust and the powers of the trustees. The deed should include a list of beneficiaries or class of beneficiaries that can benefit from the trust. It is important to carefully consider who will be appointed as trustees and ensure that they understand their responsibilities and duties in relation to the trust.

The settlors should consider preparing a letter of wishes that provides guidance to the trustees without binding them to the same.

A discretionary trust is often a strong option where flexibility matters more than certainty, where beneficiaries’ future needs are unclear, or where there is a genuine concern about

protecting assets over time. If the intention is to make a straightforward gift, or to provide someone with a right to capital, or guaranteed income, then another type of trust, or a direct gift may be more appropriate.

Discretionary trusts can be highly effective when used for the right reasons. They offer a rare combination of asset protection, flexibility, and long-term estate planning; however, they also come with legal duties, tax complexity and administrative cost. When discretionary trusts are used thoughtfully and drafted properly, they can help families manage uncertainty and protect wealth across generations. Before setting one up, it is wise to obtain professional advice, so the structure of the trust matches your goals and complies with current law and tax rules.