What is a Discretionary Trust?

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What is a Discretionary Trust?

June 5, 2021         openlegal

A trust is a legal agreement between one party to hold assets for the benefit of another. The party which holds the assets is known as the ‘trustee’ and those that benefit from the assets are known as ‘beneficiaries’.

A discretionary trust is a type of trust which provides the trustee with discretion pertaining to the selection of potential beneficiaries from a specified class and the amount of any benefit to be paid. The discretion granted to the trustee is governed by the provisions set out in the instrument used to establish the trust – known as the ‘trust deed’.

Why a Discretionary Trust?

The main benefits of a discretionary trust include:

– Flexibility to distribute trust funds or capital;
 
-Tax benefit, trustees may consider the tax related circumstances of the beneficiaries in exercising their discretion regarding the distribution of trust funds or capital, thereby optimising the tax payable by beneficiaries.

Protection of assets, discretionary trusts separate ownership from control. Beneficiaries of a discretionary trust have no legal or equitable interest in the trust property – therefore, lack any proper interest to maintain a caveat on the property.

How Does it Work?

The Settlor

A settlor (usually an accountant or a lawyer) initiates the trust by providing the initial sum to the trust and executing the deed – beyond this, the settlor does not have a role in the trust

Trustee

The trustee is vested with the trust property, however, the trustee only holds on to the assets for the benefit of the beneficiaries. The overriding duty of the trustee is to obey the terms of the trust set out in the trust deed. Failure to fulfil the terms of the trust can render the trustee liable for breach of a trust. 

Appointer

The appointer’s role is to control the trustee. The appointer is listed in the trust deed and possesses the capacity to appoint and replace trustees.

Beneficiaries

The beneficiaries of a trust are the named entities which benefit from the trust funds or trust capital. The nature of a beneficiary’s interest under a discretionary fund is mere expectancy – that is an expectation that the trustee’s discretion will be exercised in their favour. Beneficiaries also enjoy the right to have the trust properly administered.

Conclusion

Discretionary trusts are quite versatile and carry an array of benefits such as asset protection and tax optimisation. Discretionary trusts can be tailored to suit specific requirements i.e. the basis of a trustee’s discretion, this can be extremely beneficial for businesses or families seeking to utilise these advantages. 

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