A discretionary trust is a legal arrangement where trustees have the authority to decide how the trust’s income and capital are distributed among beneficiaries.
A discretionary trust is a type of trust in which the trustee(s) have full discretion to decide when and to whom the income or capital of the trust is paid. Unlike fixed trusts where the shares or entitlements of the beneficiaries are predetermined, in a discretionary trust, the trustees can choose beneficiaries, the amount, and the timing of distributions within the powers granted in the trust deed. This flexibility allows the trust to adapt to changing family circumstances or financial needs. Discretionary trusts are commonly used in wealth management to hold family assets, manage estate planning, and provide asset protection. The trustee manages the trust assets for the beneficiaries but is not obliged to distribute income or capital unless they decide to do so. This structure requires a high level of trust and fiduciary responsibility, as trustees must act in the beneficiaries' best interest while adhering to the terms of the trust.
The discretionary nature of this trust structure is highly significant in strategic wealth and tax planning. Since trustees can decide distributions annually or as needed, it enables effective income splitting among beneficiaries, potentially optimizing overall tax liabilities. This ability to control distributions offers enhanced flexibility when managing family wealth, protecting assets from creditors, or handling beneficiaries with differing financial needs or circumstances. Additionally, discretionary trusts support governance and succession planning by centralizing decision-making power in trustees rather than fixed beneficiaries, minimizing conflicts and preserving family wealth across generations. In the context of investment reporting and strategy, trustees can align distributions with the family office’s evolving financial goals and compliance requirements.
Consider a family discretionary trust with three beneficiaries: two adult children and a grandchild. The trustee can decide in a particular year to distribute 60% of income to one child, 30% to the other, and hold 10% in the trust for future use based on their financial needs and tax positions. If one beneficiary faces financial hardship, the trustee may increase their distribution that year, showcasing the trust's flexibility. If the trust earns $100,000 income in a year, the distributions could be $60,000, $30,000, and $10,000 held back, respectively.
Non-Discretionary Trust
A non-discretionary trust is a trust where the trustee has fixed obligations regarding the distribution of income and capital to beneficiaries, as defined explicitly in the trust deed, unlike a discretionary trust where trustees have distribution discretion.
What powers do trustees have in a discretionary trust?
Trustees in a discretionary trust have the authority to decide which beneficiaries receive distributions, as well as the amount and timing of those payments, all within the limits set by the trust deed.
Can beneficiaries demand a distribution in a discretionary trust?
No, beneficiaries cannot demand distributions as trustees retain full discretion; distributions are made only if the trustees decide to do so.
How does a discretionary trust impact tax planning?
By allowing income to be allocated among beneficiaries in varying proportions, discretionary trusts can optimize tax liabilities by taking advantage of beneficiaries’ different tax brackets and exemptions.
