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 difference between two of the most common types of trust – discretionary and unit trusts, how they work, and how to know which one is right for you.
We’ll start off with the basics. Firstly, 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.
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.
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.
Choosing between establishing a discretionary or unit trust can be 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 which trust to choose.
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