Probate for Discretionary Trusts

Discretionary trusts are a flexible and widely used tool in estate planning in England and Wales. When assets are placed into a discretionary trust, trustees hold and manage those assets on behalf of a class of potential beneficiaries, but no individual beneficiary has a fixed entitlement to income or capital. Understanding how discretionary trusts interact with the probate process, how they are administered after death, and what rights and duties arise for trustees and beneficiaries is important for executors, administrators, solicitors and anyone involved in estate planning. This guide explains the legal principles, administrative steps, tax considerations and practical issues associated with discretionary trusts in the context of probate.

What Is a Discretionary Trust?

A discretionary trust is a type of legal arrangement where trustees hold assets and have the authority to decide:

• which beneficiaries (from a defined class) will benefit
• how much they receive
• when and in what form benefits are distributed

Unlike other trusts where benefits are fixed or mandatory, in discretionary trusts beneficiaries have no guaranteed entitlement; trustees exercise their discretion within the terms of the trust deed. Beneficiaries' entitlements are not fixed and they cannot compel trustees to distribute capital or income.

Discretionary trusts may be established during the settlor's lifetime (inter vivos trusts) or created under the terms of a will (testamentary trusts). When set up in a will, they come into effect when the testator dies and the executor obtains probate.

Key Legal Principles

Trustee Ownership and Beneficial Interests

In a discretionary trust, trustees are legal owners of the assets and hold them for the benefit of beneficiaries. The beneficial ownership, or the right to benefit, remains subject to the trustees' discretion. Beneficiaries have only a mere hope of benefit, not a fixed right.

Probate and Trust Assets

Assets already held in a discretionary trust at the time of the settlor's death are usually not part of the settlor's estate for probate purposes because the legal title is in the trustees' names and not in the settlor's name. This means probate is not required to deal with the trust assets themselves, although a grant of probate may still be needed for other estate assets outside the trust.

However, if the trust is created by a will (testamentary discretionary trust), the executor must obtain probate before establishing the trust and transferring estate assets into it. Probate authorises the executor to collect the deceased's assets and, where the will requires, allocate them into the trust structure.

Estate Administration

Even where trust assets are excluded from the deceased's probate estate, executors often still need probate to:

• settle the deceased's debts and tax liabilities
• deal with assets not held by the trust
• distribute residual estate assets not subject to trust
• satisfy HM Revenue & Customs (HMRC) that all tax obligations have been addressed

When Probate Is and Isn't Required

Probate Not Required for Trust‑Held Assets

Assets legally held in a discretionary trust do not usually form part of the deceased's estate and, accordingly, do not require probate. This can provide practical advantages such as:

• avoiding delays in accessing funds held in the trust
• providing ongoing support to beneficiaries without estate administration delays
• maintaining privacy, as trusts are not public documents in the way probate is.

Probate Required for Other Estate Assets

Probate is still generally required if the deceased had assets outside the trust in their sole name - such as bank accounts, personal property, land, or investment assets. Probate is essential before those assets can be accessed, transferred or sold, and before creditors and tax liabilities can be settled.

Setting Up a Discretionary Trust in a Will

A testamentary discretionary trust is created by including trust provisions in a will. Typical features of such a trust include:

• a class of beneficiaries (such as children and grandchildren)
• trustees with discretionary powers
• guidance on how trustees should exercise their discretion, often through a letter of wishes (which is not legally binding but guides trustees)

To effect such a trust:

1. The executor applies for probate after death.
2. Once probate is granted, the executor gathers the estate assets.
3. The executor follows the will's trust provisions, transferring specified assets to the trustee(s).
4. Trustees administer the trust according to the terms of the deed.

Tax Considerations

Inheritance Tax (IHT)

Discretionary trusts created during life are generally treated as chargeable lifetime transfers (CLTs) for IHT purposes. A CLT is immediately chargeable to IHT at 20% on the value above the nil‑rate band, and may also be subject to periodic charges every 10 years and exit charges when assets leave the trust.

Testamentary discretionary trusts, created on death under a will, are not treated as CLTs. Instead, the estate pays IHT at the death rate (normally 40% on value above the nil‑rate band) before assets are transferred to the trust. This means there is no immediate 20% CLT on creation.

Income and Capital Gains Tax

Trustees must manage tax obligations arising from trust income and gains. Trustees pay income tax on income received by the trust, and capital gains tax on dispositions of trust assets. Specific allowances and trust tax rules apply, but trustees are responsible for ensuring compliance.

Trustee Duties After Probate

Once a discretionary trust is established, trustees have legal responsibilities that continue beyond probate:

• Act within the trust deed: Trustees must only exercise powers permitted by the trust document.
• Act prudently: Trustees should manage assets with reasonable care and skill, taking advice where necessary.
• Consider all beneficiaries: Trustees must weigh the needs of all potential beneficiaries and not favour one arbitrarily.
• Keep records: Trustees must document decisions and maintain accurate accounts.

Trustees who fail in their duties may face legal challenges from beneficiaries or regulatory issues.

Practical Issues and Risks

Beneficiary Uncertainty

Discretionary trusts depend on trustee discretion. Beneficiaries cannot demand payments and only have a right to be considered. This can lead to uncertainty and potential disputes, particularly if beneficiaries feel trustees have not properly exercised discretion.

Tax Complexity

The tax treatment of discretionary trusts - including entry charges, periodic charges and possible exit charges - can be complex. Accurate reporting to HMRC and compliance with trust tax rules is essential.

Administration and Costs

Running a discretionary trust involves ongoing administration, potential legal and accounting costs, and professional advice to ensure duties are properly discharged and tax compliance is maintained. These costs reduce the value of assets available for beneficiaries.

Common Questions

Do discretionary trust assets form part of the probate estate?
No. Where assets are already in a discretionary trust, they typically do not form part of the deceased's probate estate because legal ownership lies with trustees. Assets outside the trust still require probate.

Can a beneficiary demand a distribution?
No. Beneficiaries under a discretionary trust do not have a right to fixed payments and cannot compel trustees to make distributions; they only have a right to be considered.

Is probate always avoided by using a trust?
Only for assets actually held in the trust. Probate is still required for assets the settlor held in their name at death. Additionally, testamentary discretionary trusts require probate before they can be established.

Key Takeaways

Probate for discretionary trusts interacts with estate administration in specific ways in England and Wales. Assets held in a discretionary trust at death are generally outside the deceased's probate estate, though probate may still be needed for other estate assets. Testamentary trusts, created through a will, require a grant of probate before trust assets are established and managed by trustees. Trustees have ongoing duties and must manage tax and distribution decisions prudently. Understanding how discretionary trusts work within probate and the legal and tax implications helps executors, trustees, beneficiaries and solicitors manage these arrangements effectively.