Discretionary trusts

If you are unsure about the best way to transfer your wealth to future generations, a discretionary trust may be the flexible solution for you.

Succession planning is one of the most important steps you can take to secure your family’s financial future. But what if you’re not ready to decide exactly when, how, or to whom your assets should be passed? Family dynamics, financial needs, and life circumstances often change over time,which can make it difficult to commit to rigid plans.

A discretionary trust offers a practical and flexible way to protect your wealth, adapt to unforeseen changes, and ensure your intended successors benefit according to their individual needs. In Ireland, discretionary trusts are particularly valuable for those seeking to combine control, flexibility, and asset protection in their succession planning.

What is a discretionary trust?

A discretionary trust is a legal structure where a settlor (the original owner of the asset i.e. you) transfers assets to trustees (the decision makers of the trust) to hold those assets for a certain class of beneficiaries (such as your children).
The trustees have full discretion regarding when, how, and to which of the beneficiaries distributions are made. Typically, the settlor will write a letter of wishes to guide the trustees on how they exercise their discretion. Although the letter is not legally binding, it serves as an important document in ensuring the settlor’s intentions are considered.

Figure 1: Discretionary trust structure

Is a discretionary trust right for you and your family?

A discretionary trust is particularly suited to families with diverse needs, complex dynamics, or significant assets to manage.

It provides a way of protecting your wealth while giving trustees the flexibility to adapt to the unexpected. It also allows your wealth to be transferred at the right time for your family.

Because the charge to Capital Acquisitions Tax (CAT) does not arise until the assets are transferred to the beneficiary, it does facilitate a wait and see approach. It can also allow families to skip a generation and pass assets directly to grandchildren when the time is right. Whether you’re planning for young children, vulnerable dependents, or simply wish to ensure your family’s wealth is preserved for future generations, a discretionary trust could be the cornerstone of your succession plan.

Tax considerations

There are several other tax considerations to keep in mind when creating, and managing, a discretionary trust. Below is an overview of the key tax implications.

Discretionary Trust Tax (DTT)

Once-off 6% charge
A once-off 6% charge applies to any property that becomes subject to a discretionary trust. The tax is imposed on the latest of the following dates:

• the date of which the property becomes subject to the discretionary trust or;
• the date of death of the disponer or;
• the date on which there are no “principal objects” under the age of 21 years.
• Principal objects are the intended beneficiaries of the trust.

If the trust is wound up or all assets are distributed within five years, trustees can reclaim 50% of the tax, reducing the effective rate to 3%.

Annual 1% charge
After the initial 6% charge, an annual 1% tax applies each year on assets that remain in the trust.

Exemptions from DTT

A discretionary trust may be exempt from DTT (both the 6% and 1% charges) where it is shown to Revenue’s satisfaction that the trust has been created exclusively for the benefit of one or more named individuals who are, because of age, improvidence or physical, mental or legal incapacity, incapable of managing their own affairs. It would be necessary to get approval from Revenue that the exemption is available.

Income and gains of the trust

Any income or gains the trust generates will be subject to tax. There is also a surcharge of 20% if the trust earns income and the income is not distributed to the beneficiaries.

Tax implications on the transfer of assets to a discretionary trust

When you transfer assets into a discretionary trust during your lifetime, capital gains tax (CGT), exit tax, and stamp duty may need to be considered. There would be no CGT or stamp duty where assets are transferred to a trust under your will.

Tax treatment on distributions from a discretionary trust

The tax treatment of distributions from a discretionary trust depends on whether the payment comes from trust income or trust capital, and whether it is received by the beneficiary as income or capital. This can be a complicated area and specific advice should always be obtained.

Further considerations

• An individual’s entitlement to certain social assistance payments (e.g. disability allowance) is subject to a means test. We understand that where assets are held under a discretionary trust, they are not considered for the purposes of the means test.
• It is not tax efficient to transfer an approved retirement fund to a discretionary trust on the death of the ARF holder given how the transfer is taxed.
• The interaction between a Section 72 policy and any assets placed in a discretionary trust on your death would need to be considered.

Conclusion

A discretionary trust can be a highly effective tool for succession planning, offering flexibility, control, and protection for your assets while accommodating  for the changing needs of your family. However, it is important to carefully consider the associated tax implications and legal requirements to ensure a discretionary trust aligns with your goals.

To find out more about how we can help ensure you have a tax-efficient estate plan put in place, contact your adviser. If you’re new to Davy, why not book a consultation today?