What is a Discretionary Trust?

Jul 24, 2022

There are many types of trusts commonly used for commercial dealings, asset protection, privacy, tax efficiency or for succession planning. The type of trust appropriate for you will depend on the type of transaction or asset you are dealing with. In this series, we explore three different types of trusts: a bare trust, a unit trust and a discretionary trust. This week, we explore discretionary trusts.

What is a Discretionary Trust?

A discretionary trust is a popular structure, especially for families and for income streaming purposes. In a discretionary trust, a “settlor” contributes a nominal amount to the trust which is then held by the “trustee” for the benefit of the beneficiaries. The beneficiaries are usually defined as either being a primary or named beneficiary or will fall in the class of a general beneficiary (ie. children of the primary beneficiaries).

The main benefit of a discretionary trust is the flexibility and discretion it affords the trustee. Generally, a trustee can decide to distribute the capital or income of the trust to any one or more beneficiaries from the broad class of beneficiaries. This distribution is discretionary as trustees can elect to distribute to one beneficiary and not another.
Many families establish discretionary trusts, without having an appreciation of the number of persons who may fall within the class of beneficiaries. Depending on the trust deed, it may include current spouses, previous spouses, de-facto partners, children, stepchildren, parents, uncles, aunts, nieces and nephews and the list goes on.

Whilst there is no obligation to distribute any specific amount to those persons, there are certain obligations owed by a trustee to all beneficiaries of the trust – no matter how distant the relationship from the primary beneficiary.

Many families also have a false perception that an asset of a discretionary trust is an asset belonging to them. In fact, the asset is the property of the trust until the trustee determines to distribute the asset to any one or more of the beneficiaries of the trust. This can cause problems if the ‘controller’ of the trust hasn’t dealt with the succession of the trust upon death or considers that their Will dictates what happens. Failure to consider the succession of a discretionary trust, may result in the ‘wrong’ beneficiaries benefitting from the trust assets.

If you need advice on establishing or administering a discretionary trust, please contact Kimi Shah or Lisa George.