Estate Planning Using Discretionary Trusts in Wills

A trust created in a person’s Will in which they nominate trustees (to carry out the terms of the trust) and a range of potential beneficiaries. Legally, it is entirely up to the trustees which of the potential beneficiaries benefit, when and what they receive. The person making the Will invariably leaves a detailed note of wishes setting out their aims and the decisions they want the trustees to make. Most discretionary trusts can last for a maximum of 125 years but can be partially or completely wound up any time before this, if they are not needed.

We increasingly recommend discretionary trusts to clients where there is a possibility that one or more of their children might not need to inherit some or all of the share of the estate that would otherwise have been left to them. It potentially allows those assets to pass to grandchildren (the child’s offspring) thereby skipping a generation for IHT and avoiding those assets being subject to IHT on the death of the child and potentially saving 40% tax on those assets. The flexibility of discretionary trusts allows the trustees to decide how much of the share passes to grandchildren and when, rather than the Will maker (“Testator”) having to decide in advance. Most notes of wishes state that the trustees should follow the wishes of the child in this regard (see case study below).

There are also situations beyond the scope of this article where a discretionary trust in the Will of the first of a couple to die can save IHT on the death of the survivor, for example where one of the couple has been widowed before or where there are business or agricultural assets etc.

Whether a child is having marital difficulties at the time the Will is made or these only become apparent on the death of the Testator, it is possible for the note of wishes to state that if inheritance is likely to be vulnerable to a claim by a divorcing spouse of the child, that the trustees delay the distribution of the estate until a full financial divorce settlement is in place potentially providing protection against a claim from the divorcing spouse. Whilst this is a complex area that we frequently advise on, in many cases the trust provides greater protection than the share of the estate being left outright to the child in question.

Discretionary trusts can be used to manage assets for a vulnerable beneficiary and in a way that will not affect their entitlement to means-tested state benefits. It is usual for the note of wishes to set out how the trustees should manage monies, for example, to pay bills on behalf of the vulnerable beneficiary, rather than pay capital sums into that person’s bank account that they might struggle to manage and could affect their entitlement to benefits.

Mr and Mrs Jones are married with three children, each married and with two young children.  They have £900,000 of assets, comprising a house worth £600,000 and savings and investments of £300,000.

• Child A is wealthy, but one of her children has reasonably severe learning difficulties;
• Child B is not wealthy and Mr and Mrs Jones have concerns about the stability of his marriage;
• Child C is reasonably comfortable financially.

Mr and Mrs Jones create Wills leaving everything to each other, and on the second death, place their combined estate into a discretionary trust. The potential beneficiaries are their children and grandchildren, with their three children as trustees.

Mr Jones died five years later and Mrs Jones ten years after making the Wills.  By this time,  all grandchildren are young adults and Child B is going through a messy divorce.

As part of the administration of Mrs Jones’ estate, the trustees take legal advice and assess the best course of action for each child and their family. The discretionary trust allows them to make informed decisions rather than trying to predict family circumstances then years earlier.  

The note of wishes directs the trustees to follow each child's wishes, with each family receiving one-third of the estate (£300,000). All of the following decisions made by the trustees are carrying out each child's wishes: 

A:  The trustees pass half of A's £300k to one of her children and retain the other £150k in trust for her other child with learning difficulties, ensuring it does not affect their entitlement to means-tested benefits and saving 40% of this sum (£120,000) from IHT.  

B: The trustees retain the £300k in trust until a full divorce financial settlement is secured, ruling out claims against inheritance, then distribute the trust fund to B.

C: The trustees use £100,000 to pay off C’s mortgage and retain £200,000 in trust as a safety net, allowing C to decide later whether to use it herself or distribute it to her children.