Interactive Investor

Could you consider a DIY route to manage your family wealth?

30th August 2018 10:56

Ceri Jones from interactive investor


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Discretionary trusts offer flexibility in estate planning, but they don’t come particularly cheap. Could you set one up without professional help?

Investing in a discretionary trust is often seen as a dodge for the very wealthy, to reduce the inheritance tax due on their estates when they die and protect family businesses where succession planning may be an issue. However, discretionary trusts can also be beneficial for those with ordinary estates.

The main advantage of discretionary trusts is their enormous flexibility: trustees are given full discretion over who benefits from the trust fund and when. This means they can deal effectively with many challenges faced by ordinary families, such as providing financial support for a grandchild not yet responsible enough to look after a legacy themselves, or for a dependant with a mental health condition or learning disability who might never be able to manage their finances. Trusts may be used to meet specific future needs such as paying for a child to go to university; but they are also flexible enough to cope with unforeseen circumstances, for example when it is not yet clear what help will be required, or how many grandchildren may be born.

Another, often unsung, attraction of discretionary trusts is that on your death, trust funds can be paid out to the right people quickly, without the need for the lengthy legal processes involved in probate. This on average takes six to nine months but can take years if the affairs of the deceased are at all complicated. This could be a huge benefit if a dependant needs continual, unbroken financial support.

As families become more fragmented, discretionary trusts are also helpful where the beneficiaries from an estate are children from more than one marriage, as they can accommodate specific preferences – if you want a person to benefit only in certain circumstances (perhaps where they do not remarry), for example, or if you want to protect your wealth from spendthrift beneficiaries. The fact that trust funds are largely disregarded when calculating divorce settlements is another attraction.

Setting up

So how can you set up a discretionary trust if you are not the type of person whose family has been practising sophisticated financial planning for generations? Every professional we spoke to recommended using a solicitor to draft your trust, but this can cost upward of £1,200.

For very basic and uncomplicated trusts, you could source a pro forma draft document on the internet in a similar way that you might, for example, buy a will from WHSmith. Arguably, you do not even need a pro forma document – it is a convention because lawyers like a single format. You could just record your intentions, the property and assets you are placing in the trust, and the beneficiaries and trustees you have chosen. As long as the wording of that record shows a clear intention to set up a trust, it becomes a legal arrangement. Technically, even a spoken statement constitutes a legal arrangement, although few would want to put that to the test.

Document basics

There are two parts to discretionary trust documentation: the trust deed and the letter of wishes. The trust deed is the legal document that creates the trust – signed by you, as the settlor, and the trustees, and naming the parties involved, their roles and the assets being put into trust. The main pitfalls here are failing to unambiguously define the beneficiaries and not identifying assets clearly.

The letter of wishes is a set of instructions detailing your preferences regarding how the trust fund should be used and allocated. However, while most trustees will try to implement your wishes, the letter of wishes is not legally binding on them, so trustees have discretion over what payments they make to beneficiaries and when. You can rewrite the letter of wishes at any time.

Having completed these two documents, you will then need to make it known that the trust exists by putting it somewhere obvious such as a household safe, or lodging it with your bank or a professional adviser, and by letting the trustees and your executor know where it will be. If one of the beneficiaries is a vulnerable person, perhaps with a mental health problem, it would be wise also to lodge a copy with adult social care or an advocacy agency.

If you decide to use a standard trust draft, the safest way to proceed is simply to insert the names of the trustees and beneficiaries. The trustees can then use their power to make whatever appointment is desirable at the relevant time. Problems arise most frequently when settlors amend standard drafts or provide their own wording entirely to suit their circumstances. Curtailing flexibility in this way can cause unexpected problems.

The letter of wishes can be as personal as you like, however. Make sure there can be no arguments about who you would like to benefit and under what circumstances. Ask yourself whether it is perfectly clear who is entitled to both trust income and trust capital at any stage.

Pitfalls and problems

It is a common mistaken belief that trustees must adhere to the letter of wishes. Patricia Mock, tax director at Deloitte, says: ‘Trustees can in fact choose to follow or ignore the letter of wishes as they see fi t, depending on their assessment of whether this is in accordance with their fiduciary duties to all the beneficiaries.’

Another common misconception among those setting up trusts, she adds, is that money in trust still belongs to them. She explains: ‘Sometimes people settle funds into a trust without realising that it is no longer their money, and instead must be dealt with according to the terms of the trust and any discretionary instructions the trustees may have.’

Clearly, therefore, choosing trustees carefully is of utmost importance. You should select at least two trustees with a mix of skill sets, preferably resident in the UK (for tax reasons). Most importantly, they must be people you believe will act in the beneficiaries’ best interests. While the trustees need to be at least 18 years old, it is helpful if one or two are the same age as the prime beneficiaries. This avoids a common difficulty with wills, where the executor chosen is a family friend or sibling of the deceased who is themselves elderly or has died by the time probate needs to be managed.

As trustees must agree on any action unanimously, it may make sense to ensure that at least one trustee is not a family member. Solicitors and accountants can act as trustees. The cost of their professional services may be worth meeting if you think the situation down the line could become rancorous. Strict fiduciary duties are imposed on trustees, which any trustee looking after the assets should be fully versed in and adhere to.

Many wills provide for a discretionary trust to be set up on death, although trusts can be set up at any time to make gifts during one’s life. A discretionary trust set up on death gives trustees flexibility regarding the distribution of funds, depending on circumstances at that time, and may mean that your will needs to be reviewed less frequently. The trust can run for up to 125 years.

Once a trust deed has been executed, it cannot simply be amended if you change your mind. Even where a genuine mistake has been made and you can provide evidence to support this, you still need to apply to a court, which will take a view on the matter.

Nick Parkinson, tax director at Grant Thornton, says: ‘While someone could set up a trust themselves, the rules governing them are quite complex, and without expert advice, they could end up with something quite different from what they intended – even a different type of trust. The fact that a trust is called discretionary does not mean it is. It depends on the clause wording in the trust’s deed.’

Tax challenges

The applicable tax schedules of a trust can be complicated, particularly as various asset types are treated differently. ‘The terminology involved can be difficult to understand and the tax implications are often complex,’ says Lisa Davies, head of succession and tax (Wales) at Blake Morgan. The trustees will have certain tasks to perform, such as completing an annual tax return and reviewing investments. ‘Some of these tasks may be performed without professional assistance if the trustees have the necessary knowledge and skills,’ she adds.

However, she warns: ‘While on the face of it, setting up your own trust may look like a fee-saving measure, the potential costs and penalties when things go wrong make this a definite false economy. For example, there is a possible inheritance tax charge when capital is paid out of a trust to a beneficiary, and the trustees would be personally liable for this if they over-distributed the trust fund without realising and had therefore not held back funds to pay the tax.’

This article was originally published in our sister magazine Money Observer, which ceased publication in August 2020.

These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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