What is a Discretionary Trust?

Discretionary trusts are a form of trust whereby the appointed trustee holds assets, which can be real property, money, shares or any other asset. These assets are merely held by the trustee on trust for the beneficiaries of the Trust.

The trustee has the power, amongst other powers, to make investments and lease property for the trust. Additionally, the trustee has the discretion to distribute any capital or income of the trust to the beneficiaries.

As the trust is discretionary, this means that the Trustee has discretion as to whom or how much they distribute to a beneficiary. For example, there may be two named beneficiaries, but this does not mean that the income must be distributed equally. Instead, the trustee may choose to distribute more to one than the other, or only to one of them.

The trustee may also be restricted to distribute to only a certain “class of beneficiary”, this is not a named beneficiary, but a class within the trust deed that dictates what counts as a beneficiary. For example, The Discretionary Trust Deed of the Adams Family may have a clause stating that all members of the family, whether by blood or marriage, are entitled to benefit from the trust. This does not directly name the beneficiaries specifically and leaves it open to any new or old members of a family to be a beneficiary.

What are the advantages of having a Discretionary Trust

 There are different reasons why someone may set up a Discretionary Trust. Some common advantages of having a Discretionary Trust are:

1. Asset Protection. Assets that are held in trust are separate from any assets held in someone’s personal name. This means that these assets can be protected to an extent if someone finds themselves in bankruptcy or liquidation.

2. Tax Savings. By having income generated from assets in a Discretionary Trust, the Trustee can decide to whom it pays the income. This means that the income can be distributed amongst the beneficiaries, lowering overall the tax payable if the beneficiaries are in a lower taxation bracket. 

3. Capital Gains Tax Benefits. Depending on the circumstances and the assets, assets held in a discretionary trust may have access to capital gains exemptions or concessions. 

4. Safekeeping funds for dependents. A trust can be used to distribute income and capital to dependents once they attain a certain age. They can also be useful as an estate planning tool to protect your assets and funds if you pass away and be distributed to your beneficiaries in accordance with how you wish for them to receive their funds, as opposed to immediately after you pass away. 

What are the disadvantages of having a Discretionary Trust 

Some of the common disadvantages of having a Discretionary Trust include:

5. Compliance Costs. Each year the Trust will need to lodge tax returns and have financial reports prepared. There are also annual ASIC fees that are payable if the fund has a corporate trustee. If the Trust does not generate a high level of income, the compliance costs can be disadvantageous. Trusts are also charged higher rates on charges like land tax.

6. The Trustee controls how the income and capital are paid. Whilst having the trustee control who is paid the income and capital of the trust can be an advantage, it can also be a disadvantage if the trustee is not acting in the best interests of the beneficiaries or only distributing the income and capital to certain beneficiaries that might advantage them. 

7. Beneficiaries do not own the assets of the trust. Even though you are a beneficiary of the trust, you do not own the trust assets in your own name and do not have control over the assets. This means the Trustee has the power to buy, sell or transfer assets and you have no control over this. 

8. Taxation Consequences. Used properly, a Discretionary Trust can have taxation advantages. However, it can also have taxation consequences. If the trustee does not distribute income to beneficiaries, the income of the trust may get taxed at a high tax rate than the beneficiaries if the income was distributed to them, meaning there is less money to be distributed to the beneficiaries later. 

Tax losses that the trust incurs stays with the trust. The trust tax loss cannot be offset against an individual’s tax income.

What are some Common Issues in Discretionary trusts 

9. Appointors (sometimes called Guardians/Custodians) with no succession clauses. The appointor is the person named in the deed who usually has the ability to remove the trustee of the Trust and to appoint a new Trustee. A lot of trust deeds we have seen do not allow for the original appointor to appoint someone new in their place. Not having a mechanism to replace the appointor can pose serious issues for the trust and can be very costly to resolve, particularly if the Appointor passes away.

10. Vesting Day. This is the day which the trust ends. It cannot be any more than 80 years from the day of establishment. Some trusts that have a shorter vesting date such as 20 or 30 years from the establishment of the Trust.

When the trust vests, there should be a procedure in the trust that outlines what must be done to properly wind up the trust. The trustee will be required to determine the trust’s assets, discharge any liabilities, make final distribution, and verifying the trust accounts and making statements available to the beneficiaries.

Not being careful and diligent about the vesting day will have tax implications. The vesting date cannot be changed after the date has passed, if the vesting date has passed, then you will need to create a new trust. If you require the vesting day of your trust to be varied or require advice on the vesting date, please contact our office.

11. Restrictive Class Beneficiaries Clauses. Although it sometimes beneficial to put in a “class of beneficiaries” clause, it is paramount that you understand that a clause may be too specific and therefore the beneficiaries may not be who you actually wish, or there may be little room for the trustee to exercise their discretion in distribution. If you wish to have very specific distribution clauses made that are also future-proofed or if you wish to vary or amend your existing clause/s, please contact our office.

Can I just buy an off-the-shelf Discretionary Trust? 

You can, but it is not recommended. As the name suggests, an off-the-shelf Trust is simply a standard Trust Deed containing standard terms. An off-the-shelf Trust does not take into account your specific circumstances or intentions for the Trust, including to whom the Trust can distribute funds or how Trustees and Appointors can be removed or replaced.

Whilst it may not seem like an issue now, if something were to happen or change, the off-the-shelf trust deed may not protect you or the beneficiaries of the trust. If this happened, it can be more costly and stressful to try to remedy the situation. Setting up a trust deed with your specific goals and intentions right from the beginning is the safest way to protect you.

If you have any further enquiries about discretionary trusts, wish us to review your discretionary trust or would like to set one up, please contact our office on (03) 9707 1155 or admin@wslegal.com.au.