You’re probably familiar with the concept of a ‘trust’, which is a complicated enough area of law on its own. Beyond this, there are different types of trusts, which all work in different ways for the beneficiaries they serve. Some trusts will allow the trustee to have unlimited discretion, and some will have terms the trustee has to abide by. In this article, we’ll explain the differences between a discretionary vs a unit trust, how they work, and how to know which one is right for you.
We’ll start off with the basics. First, we will quickly identify some of the key terms in a trust agreement.
The subject of the trust agreement, and reason the agreement is created in the first place. The beneficiaries receive the trust property. Trust property can be in the form of money or assets such as real estate or securities.
An appointor is the ultimate controller of a trust. They may be directly related to the trust, such as a named beneficiary. They may also be existing trustees or a third party. A trust may have an ‘independent’ appointor. This is usually a professional, such as an accountant.
A settlor basically sets up the trust for you. They then legally transfer the responsibility of managing the assets to a trustee.
The party holding property for the benefit of the beneficiary. There can be more than one trustee, but there cannot be a sole trustee when the same trustee is the sole beneficiary of the property. Trustees have strict obligations to act in the best interests of the beneficiaries. They also have to act in good faith, to be impartial, and to preserve the trust property.
The beneficiary is the party who receives the benefit of the trust. There can be more than one beneficiary in a trust. Beneficiaries have certain legal rights (such as taking action if the trustee has breached their duties), but these may vary depending on the terms of the trust deed.
The agreement which establishes the trust and outlines how it is to be administered. This document should also outline how any amendments to the trust are to be made and when the trust is to expire.
Let’s say you create a trust agreement (‘the agreement’), where your father (Richard) holds your investment property on trust for the benefit of your three children – Xavier, Janet, and Ashley.
The terms and key stakeholders are:
- Trust Property: Your investment property
- Trustee: Your father (Richard)
- Beneficiaries: Your three children (Xavier, Janet, and Ashley)
- Trust Deed: The agreement this is set out in
We’ll now discuss the difference between the trust being a discretionary and unit trust.
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.
In this case, Richard would have the choice of splitting up the investment property however he wanted among Xavier, Janet, and Ashley. Richard can split the whole property into equal thirds, allow Xavier to have a higher share, or even give the whole property to him. Richard would distribute the property by allocating shares. Here’s some examples of them:
Xavier, Janet & Ashley
- Janet: 33%, Xavier: 33%, Ashley: 33%
- Xavier: 25%, Janet: 25%, Ashley: 50%
- Xavier: 60%, Janet: 30%, Ashley: 10%
- Ashley: 5%, Janet: 90%, Xavier: 5%
As you can see, there are no limits in Richard’s discretion when allocating shares. He has complete freedom in a discretionary trust. It is important to note however, that Richard only has discretion in allocating the property to the beneficiaries. The terms of the trust specify that the class of people to benefit are your children, and no one else. This setup would allow Richard to distribute the trust property flexibly over time. This allows him to consider broader contextual factors. For example, he may note the differing circumstances of the beneficiaries over time. He may also consider the tax positions of the beneficiaries in a given year. As such, this form of trust is popular for family trusts.
Unit trusts are fixed, express trusts. Unlike discretionary trusts, unit trusts allocate the shares in the property for beneficiaries in the trust agreement, rather than discretion by the trustee. Each beneficiary is allocated a unit in the trust property beforehand.
In your Trust Deed, the shares in the investment property are now determined by what was set out in the agreement. The trust agreement can say that Richard has to split the property evenly, or that Janet receives 50% of the shares, while Xavier and Ashley receive 25% each. The main difference between a unit and discretionary trust is that you make that decision in your agreement, rather than Richard in the future. You can also combine the two for a hybrid trust. In this case, Richard can choose which children get the shares, but they will have to be distributed equally, or in the terms set out in the trust agreement.
This setup is particularly popular for investment schemes. This is because the value of the trust property can be invested in complex ways, but the share entitlements of each beneficiary is secured to their unit proportion. However, because of this use, it is important to note that this kind of trust can get really complicated. This is because managed investment schemes are regulated under the Corporations Act 2001 (Cth) by ASIC. If you are thinking about setting up a unit trust for investment purposes, we recommend chatting to a lawyer to understand your legal obligations.
Choosing between establishing a discretionary vs a unit trust can seem like a difficult choice. Ultimately, it will depend on the level of certainty that you want at the time of agreement. Before making a trust, you should also consider the stamp-duty, tax, and other implications of your choice. You can connect with an estate planning lawyer on our lawyer marketplace if you want further advice on the benefits of a discretionary vs a unit trust.