A discretionary trust is often used to conduct financial affairs of family groups. In this type of trust the trustee is not told to divide assets or income to beneficiaries in a specific way - instead, it is up to the trustee's - or multiple trustees' - discretion.
So what are the pros and cons of a discretionary trust? In a 2010 speech to the National Family Law Conference the Honorable Justice Paul Brereton outlined some of the issues that a trustee of a discretionary trust may face.
The parties involved in the establishment of a discretionary trust are the settlor, the appointor, the trustee and the beneficiaries. The settlor places the assets into the control of the trustee. The role of the appointor is to remove or appoint the trustee, as well as having a strong interest in the trust. The trustee is the person whose role it is to distribute the income on an annual basis and capital on the vesting date to the beneficiaries.
Discretionary trusts are often set up to provide for a family group. Therefore the beneficiaries are usually the spouse, children, grandchildren and individuals with a remote connection to the appointor.
Pros of a discretionary trust
Justice Brereton stated that discretionary trusts can be an attractive option for a family trust. The first reason Justice Brereton gives is that discretionary trusts allow for the accumulation of assets for beneficiaries. The assets and capital of the trust can then be distributed with minimal taxation consequences.
Another reason discretionary trusts can be a good option is because they have an element of flexibility over how the capital and income is distributed. If the circumstances of a beneficiary were to change the trustee uses their discretion to decide on the allocation of funds.
Cons of a discretionary trust
One of the cons associated with a family trust is that the beneficiaries do not have equitable or proprietary legal interest in the trust property. The trustee has the discretion to split the income of the trust between the family group over a period of time as they see fit.
The High Court of Australia decision in Kennon vs Spry found that assets in discretionary trusts may be considered in property settlement agreements. If there is a relationship breakdown and an application for division of relationship property is made, the Spry decision becomes particularly pertinent.
Talk to a lawyer If you are interested in how a discretionary trust would work and if it should be part of your estate planning. For further explanation, you can read a previous post on our blog of the basic elements of a discretionary trust.