Becoming a trustee can often feel like navigating unfamiliar territory, especially if it’s your first time taking on this responsibility. In this post, we will explore how to manage the role efficiently and avoid common pitfalls that may arise.
What is a Discretionary Trust?
A trust is a legal structure that holds assets for the benefit of others. These assets can include investments, cash, property, or land. The person who creates the trust is known as the settlor, and they appoint one or more trustees to manage the assets. A discretionary trust gives trustees the freedom to decide when and how the assets are distributed among the beneficiaries. This flexibility ensures that trustees can respond to changing circumstances, such as the beneficiaries’ needs or life events, and manage the trust’s assets in the best interests of everyone involved.
When is a Discretionary Trust Most Useful?
A discretionary trust is particularly helpful when you want to set aside money for someone but don’t fully trust them to manage the funds responsibly. For example, if you wish to give a large sum of money to a young person, such as a 17-year-old, you may want to avoid them spending it impulsively on things like a new car or partying. By placing the money in a trust, you can ensure that it’s used according to your intentions, such as funding education or a home deposit.
However, once the assets are in the trust, they no longer belong to the settlor. Any personal benefit from the trust could trigger specific tax rules, so it’s important to understand the full implications before setting one up.
Tax Considerations for Discretionary Trusts
Trusts can have a significant impact on tax planning, and understanding how the trust invests and distributes money is key to managing these implications. A discretionary trust is subject to various tax rates:
- Dividends are taxed at 39.35% (no dividend allowance is available).
- Income above £1,000 is taxed at 45%.
- Capital gains above the annual allowance of £3,000 are taxed at 20% or 28% (depending on whether the gains are from property).
It’s also important to note that discretionary trusts established after 2006 incur periodic charges every 10 years, along with exit charges based on the trust’s value.
The Trustee Act 2000
The Trustee Act 2000 lays out the roles and responsibilities of trustees, giving them the power to seek professional financial and investment advice. Trustees should not feel they need to manage the trust alone if they lack expertise. For example, I once worked with a client who was a trustee for a family trust intended to support a grandchild’s university education. By carefully planning the finances and utilizing the available allowances, we ensured the maximum net income could be used while minimizing tax.
Maintaining a Diverse Investment Portfolio
A key aspect of trust management is maintaining a diverse investment portfolio. Diversification helps reduce risk, especially in volatile markets. In 2022, for example, both bonds and equities fell simultaneously, and having investments spread across different asset classes and geographies proved vital in achieving better returns. If you’re not familiar with managing investments, outsourcing this responsibility to an expert, such as a discretionary fund manager (DFM), is a smart choice.
Regularly Reviewing the Trust’s Suitability
It’s essential for trustees to ensure that the trust’s investment strategy remains suitable over time. This involves considering factors like the beneficiaries’ changing circumstances, the overall financial situation, and the trust’s objectives. Trustees are responsible for making decisions that align with these factors, ensuring the trust’s assets are managed appropriately.
The Importance of Ongoing Reviews
Trustees must regularly review the investment strategy to ensure it meets the trust’s goals. If there are significant changes in the family’s situation or the market, it’s crucial to adjust the strategy accordingly. Working with a professional can help ensure that the investment solution remains suitable, and any necessary changes are made.
What Happens When Things Go Wrong? The Case of Daniel v Tee
In 2016, the case of Daniel v Tee highlighted the consequences of poor trust management. In this case, the trust suffered a significant loss of £1.5 million due to mismanagement, with an over-concentration in equities, resulting in a high level of risk. The trustee argued that they had acted honestly, but the court sided with the beneficiaries, finding that the trustees had failed to develop a reasonable investment strategy. This case underscores the importance of high-quality financial planning and investment advice for trustees.
Conclusion
Trustees play a critical role in ensuring that assets are managed in line with the trust’s objectives. They must act diligently, regularly review the trust’s suitability, and seek professional advice when necessary. By doing so, trustees can ensure that the trust operates efficiently and effectively, fulfilling the settlor’s intentions and securing the financial future of the beneficiaries.
