Advantages and Disadvantages of a Discretionary Trust (2021 Update)
Discretionary trusts give a trustee discretion when distributing trust property. Find out the advantages and disadvantages of a discretionary trust here.
If you’re considering operating your business through a discretionary trust, it is important to understand whether and why this structure is appropriate for meeting your objectives. In particular, you may want to compare it to a fixed trust and other business structures. In this article, we’ll outline the advantages and disadvantages of a discretionary trust.
Table of Contents
- What are Discretionary Trusts?
- The Advantages & Disadvantages of a Discretionary Trust
- Article Summary
- The Next Steps After Setting Up a Discretionary Trust
What Are Discretionary Trusts?
Before we can understand what a Discretionary Trust is, we must define what a Trust is. A Trust is an obligation imposed on a person or other entity to hold property for the benefit of the beneficiaries. A Trust is split between two parties. A “trustee” – the person who manages the Trust on behalf of the beneficiaries. The “beneficiary” – the people who own the property/assets.
Discretionary trusts are when the trustee chooses which beneficiaries receive the trust property, and how much of the trust property they get. The discretion is in the trustee having the option of splitting up the trust property however they like. There are no limits in a trustee’s discretion when allocating shares, as there is complete freedom in a discretionary trust.
Advantages and Disadvantages of a Discretionary Trust
In a discretionary trust (sometimes called a ‘family trust’), the trustee has the power to determine which beneficiaries receive the property or assets from the trust and how much each is to receive.
The trustee’s power only extends to nominated beneficiaries in the trust. Entitlement to assets is not predetermined and fixed, as is the case with a fixed trust. From a business standpoint, a fixed structure, such as a fixed unit trust, may be more appropriate where the beneficiaries are unrelated third-parties sharing property and shares. For more information, check out our guide on discretionary trusts to learn more about this structure. It is always advisable to talk to a estate planning lawyer when establishing or altering a trust.
Advantages of a Discretionary Trust
A discretionary trust can be beneficial for asset protection and tax purposes. Some potential benefits of this structure include:
- Estate planning for the benefit of members of the “family group” in the event of an unexpected death
- Trust property is exempt from creditors. A creditor cannot take trust property in bankruptcy or liquidation (unless the debt was originally a trust debt)
- Tax minimisation, as individuals can receive a 50% Capital Gains Tax exemption under a trust
- Flexible and easy distribution of trust income and capital
Disadvantages of a Discretionary Trust
The disadvantages are inclusive of:
- Complexity in establishing and maintaining a trust structure
- Only profits (not losses) are distributed
- Vesting date: in NSW, trusts generally end after no more than 80 years; extending this date requires foresight in drafting the trust, otherwise, you may face costly court action
- Investors are more likely to invest in a company structure rather than a trust structure
Trust: an obligation imposed on a person or other entity to hold property for the benefit the beneficiaries. There are two parties at play, the trustee and the beneficiary.
Discretionary Trust: when the trustee chooses which beneficiaries receive the trust property, and how much of the trust property they get.
At the end of the day, it’s important to seek professional help as to whether or not a Discretionary Trust structure is for you. It’s most notable that they are great for estate planning and the flexibility in the distribution of trust income and capital. However, if you are seeking investment, a Discretionary Trust may be unattractive to potential investors due to the liability that is involved with it.
Deciding on a business structure is a necessary but often daunting step. If you have further questions about establishing a discretionary trust, it may be worth getting in touch with a lawyer.
Zac is a consultant at Lawpath, Australia’s largest and fastest growing online legal platform. Since joining Lawpath, Zac has assisted 1000s of startups and small business’s with their legal needs.