What is a discretionary trust?
A discretionary trust is a trust that has been set up for the benefit of one or more beneficiaries, but the trustee is given full discretion as to when and what funds are given to the beneficiaries. The beneficiaries of the trust have no rights to the funds, nor are the funds regarded as part of the beneficiaries’ estates.
With most trusts, the beneficiaries are entitled to a certain proportion of the trust income, depending on the terms of the trust. They may receive a monthly allowance or receive the money when they reach a certain age. Because of this, the beneficiaries are considered beneficial owners.
A discretionary trust is different in that the beneficiary cannot claim or demand funds from the trust at any stage. The allocation of funds is entirely at the discretion of the trustee.
This has the effect of protecting beneficiaries who may not have the ability to use the funds wisely. It also provides protection against creditors, who cannot attach the trusts funds’ assets.
Beneficiary funds are good for situations when the beneficiaries are immature, disabled, mentally impaired, irresponsible, spendthrift, gamblers, or are in debt or bankrupt.
The trustee of a discretionary trust has complete control over the fund and is regarded as the legal owner. Even though the trustee cannot benefit from the fund, it’s possible that the trustee won’t adhere to the grantor’s wishes and, for this reason, a discretionary trust may have “appointers” who have the power to remove the trustee and appoint a new one. Another method of limiting the discretion of the trustee is to appoint a guardian who has the power to veto distribution decisions.
Discretionary trust example
Frank and Mary have a young family. Frank is wealthy but in ill health and wants to ensure his children are looked after. Because of their young age, he is concerned they won’t have the maturity to use the money carefully. He sets up a discretionary trust, using a trusted friend as the trustee. By doing this, he knows his trustee will ensure that his children’s needs are met, and the discretionary trust ensures they cannot waste the money.
Estate planning is an important part of life. Find out more about using trusts to reduce estate taxes.