WHAT IS A DISCRETIONARY TRUST?
A discretionary trust is generally a trust under which the distribution of income or capital to beneficiaries is made at the discretion of the trustee. Until the trustee exercises its discretion, the beneficiaries generally have no interest in the property of the trust. A discretionary trust is sometimes called a “family trust” (however, for tax reasons, a “family trust” means a trust that has made a “family trust election”).
The trust deed of the XYZ Family Trust provides that the income and capital of the trust can be distributed to the benficiaries of the trust as determined by the trustee each year. This is a discretionary trust.
Not a discretionary trust
Jack and Diane own half of the units each in the ABC Unit Trust. This is a not discretionary trust.
WHAT ARE THE BENEFITS OF A DISCRETIONARY TRUST?
The benefits of a discretionary trust include the following:
- Potential asset protection;
- The trustee has flexibility regarding the distribution of income and capital;
- Less regulation than a company;
- The trust deed can be tailored to the needs of principals and beneficiaries; and
- Easier to wind up than a company.
One of the main advantages of a discretionary trust is the ability to distribute income and capital tax effectively. The trustee is able to either distribute income to the beneficiaries or accumulate it (although accumulating causes its own problems – i.e., the trustee may be taxed on such amounts at the top tax rate). None of the beneficiaries are able to force the trustee to distribute income in a particular way.
The principal benefit of using a trust to carry on a business or hold assets is that no single beneficiary has any claim to any assets of the trust (apart from any unpaid distributions they remain entitled to) and therefore a trust provides a good way to obtain asset protection.