As the description infers, discretionary trusts are structures under which the controllers (in this case, trustees) exercise their discretion in undertaking various aspects of their responsibilities. The most interesting one for asset protection and for taxation purposes is the degree of discretion the trustee has over the distribution of income – and of assets.
…but, what is a Trust?
A trust is a relationship between the trustee (who legally owns the assets on behalf of the beneficiaries) and the beneficiaries themselves. It is created by a written document called a trust deed: and may be created as the result of a Will (a testamentary trust); or to hold investments of a close group or family (a ‘family’ trust).
The founding deed contains a set of rules which, in conjunction with trust law, determine what the trustee can and cannot do with the trust’s income and assets. The trustee is bound by these rules and is expected to manage the trust’s assets with at least as much care as it would its own financial affairs.
The trustee holds title to the capital assets of the Trust; and manages them for the benefit of the beneficiaries. The Trustee also decides when the income and capital of the trust are to be distributed. The beneficiaries have no prior legal right to the income or the capital of the trust and only become entitled to distributions once the trustee has made such determination. (This is an important issue to be considered when drafting an Estate Plan: many people confuse Trust assets as being theirs to bequeath – which is not directly the case.)
Professional advice should be taken in setting up a trust deed as the trustee is only permitted to act as specified by the deed.
What is a Discretionary Trust?
A discretionary trust is a Trust operated as above – but with the distinction that the trustee exercises a discretion as to which of the eligible beneficiaries are to receive any income earned by the trust or any capital they choose to distribute.
What are the advantages of such a trust?
Some of the main advantages of a discretionary trust include:
- Efficient tax planning for families – income flows can be directed to members with a low marginal tax rate,
- Asset protection – in the event of divorce, bankruptcy or legal action; and
- Effective estate planning.
Who are the stakeholders in a trust?
The parties to a discretionary trust, are similar to those in most commonly observed trusts: they include –
- Settlor – The settlor is the person who establishes the trust, conferring assets to the trustee for the benefit of the trust beneficiaries. For taxation purposes the settlor cannot be the sole beneficiary.
- Trustee – The trustee is the person or entity who holds the assets on behalf of the beneficiaries. They are the legal owners of the assets and must manage the trust. The trustee may also be a beneficiary of the trust.
- Beneficiary – Beneficiaries are those who are entitled to receive a distribution from the trust. They can include individuals, companies and other trusts. Beneficiaries (or the class of beneficiaries) should be – and usually are, identified in the trust deed.
- Appointor – An appointor can be nominated in the trust deed and is the person who has underlying control of the trust. They have the power to change the trustees of the trust if they wish. A discretionary trust does not need to have an appointor, but it is generally advisable that consideration be given to appointing one. In some circumstances the Settlor also acts as the Appointor.
Do discretionary trusts pay tax?
Generally, the trustee of the trust does not pay tax on the income that has been earned by the trust if it is distributed in full. Any income retained within the trust and to which no beneficiary is presently entitled, is taxed at the maximum marginal rate (at time of posting, this was 46.5 per cent, including the Medicare Levy).
As a beneficiary, any income that you receive from a discretionary trust is assessable to you. The income will hold its character as if it was directly earned by you outside the trust relationship, for example, dividend income. This income may include franking credits and grossed up capital gains or losses. (You should refer to your Tax Agent or other tax professional for personal advice as to how these distributions affect you.)
Do I need a trust to best manage my wealth accumulation?
Where it is appropriate, we recommend the use of discretionary trusts by our clients to hold identified investment assets that are ultimately intended to benefit the family or particular dependants. The experienced advisers at Continuum Financial Planners Pty Ltd are able to provide wealth management advice to trusts as well as companies, self-managed superannuation funds (and to advise on the benefits of using particular structures to hold wealth); as well as to individuals. To learn more about how our advisers can bring value to achievement of your investment goals, phone 07-34213456, or complete the online request form at our website Contact Us page to make an appointment to meet with one of our team: ‘we listen, we understand; and we have solutions’ to your wealth management needs, that we deliver in personalised, professional advice.
(This article, originally posted in August 2009, has been updated/ refreshed occasionally since, most recently during January 2020.)