What is a Discretionary Trust?
A Discretionary Trust is a type of trust where the shares or benefits distributed to each beneficiary are not predetermined or fixed by the settlor (the person who creates the trust) in the trust deed. Instead, the trustees (those who manage the trust) or another appointed person have the discretion to decide how the trust’s income or capital will be distributed among the beneficiaries. This flexibility is particularly useful when the needs of the beneficiaries are likely to change over time, such as in the case of minor children or beneficiaries with unpredictable financial needs.
Key Features:
- Flexibility: The trustees have the discretion to vary the distribution of income or capital among the beneficiaries.
- Changing Needs: Suitable for scenarios where beneficiaries’ needs may change over time.
- Tax Benefits: Historically used to mitigate inheritance tax liabilities, though regulations have evolved over time.
Examples of Discretionary Trusts:
Family Trust:
- Set up by parents or grandparents for the benefit of their children or grandchildren. Trustees can decide to provide more income to a beneficiary who needs financial assistance due to education, health issues, or other reasons.
Charitable Trust:
- Established to distribute funds to various charities at the discretion of the trustees. Allows flexibility in supporting different charitable causes over time.
Employee Benefit Trust:
- Created by a company for the benefit of its employees. Trustees have the discretion to award bonuses or benefits based on performance and company profitability.
Frequently Asked Questions (FAQs):
Q1: Who can be the beneficiaries of a Discretionary Trust? A1: The beneficiaries can be individuals, family members, or even organizations like charities. The settlor defines the class of beneficiaries when creating the trust deed.
Q2: What are the powers of the trustees in a Discretionary Trust? A2: Trustees have the power to decide how much income or capital each beneficiary receives, and they must act in accordance with the trust deed and in the best interests of the beneficiaries.
Q3: Are Discretionary Trusts subject to inheritance tax? A3: Yes, discretionary trusts are typically subject to inheritance tax rules. Since April 2008, many forms of trusts were reclassified affecting their tax advantages.
Q4: Can beneficiaries challenge the trustees’ decisions in a Discretionary Trust? A4: Beneficiaries can challenge trustees’ decisions if they believe the trustees are not acting in accordance with the trust deed or their fiduciary duties. Legal advice should be sought in such cases.
Q5: How are income and gains taxed in Discretionary Trusts? A5: Income and capital gains within a Discretionary Trust may be subject to different tax rates compared to individual beneficiaries and differ depending on jurisdiction.
Related Terms:
- Trust: A fiduciary relationship in which one party, known as a trustee, holds legal title to property for the benefit of another party, the beneficiary.
- Accumulation and Maintenance (A & M) Trusts: Trusts where income is accumulated and not immediately distributed to the beneficiaries, particularly for young minors’ future use.
- Relevant Property Trusts: Trusts subject to specific tax regimes, including inheritance tax regulations.
- Investment Trust: A form of trust where managers have discretion over investments, distributing returns to the beneficiaries or reinvesting them.
Online References:
Suggested Books for Further Studies:
- “Trusts and Equity” by Richard Edwards and Nigel Stockwell
- “Trusts Law: Text and Materials” by Graham Moffat
- “Drafting Trusts and Will Trusts: A Modern Approach” by James Kessler QC and Charlotte Ford
- “The Law of Trusts and Trustees” by Geraint Thomas and Alastair Hudson
Accounting Basics: “Discretionary Trust” Fundamentals Quiz
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