A discretionary trust, in the law of trust law of England, Australia, Canada and other common law jurisdictions, is a trust where the beneficiaries and their entitlements to the trust fund are not fixed but rather are determined by certain criteria set out in the trust instrument by the settlor.
Discretionary trusts can be discretionary in two respects:
1. The trustees usually have the power to strategically determine which beneficiaries (from within the class) will receive payments from the trust.
2. Trustees can strategically select the amount of trust property that the beneficiary receives.
Discretionary trusts can usually be subdivided into two types:
exhaustive, where the trustees must distribute all income accruing to the trust fund; and
non-exhaustive, where the trustees have an express power to accumulate income.
In a discretionary trust, the settlor transfers ownership of assets (money, property, investments) to the trust. The trustee then has the discretion to decide how and when to distribute those assets to the beneficiaries the settlor designates. This empowering arrangement may give the settlor more control over their estate compared to a standard will. Upon the death of the settlor, the terms of the discretionary trust govern the transition of assets. Trustees may continue to lawfully manage the trust, adjusting distributions according to the trust deed’s provisions.
In the past, it was commonly known that for the trust to be valid, the trustees had to be able to draw up a “complete list” of all the possible beneficiaries, and if they could not do so, the trust would be void. That was changed after the decision of the House of Lords in McPhail v Doulton, where the court restated the test for certainty of objects in connection with the trust. In this case, the court held that provided it could be said of any person whether they were “in or out” of the class, as described by the settlor, the trust would be valid.
Duties of Trustees
The ordinary correlation between beneficiaries’ rights and trustees’ duties in fixed trusts can be absent in discretionary trusts. In 87 L. Q. Rev. 31 (1971) Trust, Power and Duty, It has been suggested that “the discretionary trust, in fact, depends on a rule-concept of duty, with no such necessity for correlative rights.
However, whilst the beneficiaries could have the right to sue the trustees in case of any failure to fulfil their duties, such recourse would be assessed on a case-by-case basis.
Will Trusts and Discretionary Trusts
Will trusts, established through testamentary documents, come into effect upon the death of the testator, whereas discretionary trusts can be created during one’s lifetime or through a will. Will trusts typically specify fixed beneficiaries and terms of distribution, whereas discretionary trusts provide trustees with latitude in determining beneficiaries and allocations.
Disadvantages of Discretionary Trusts
Despite their flexibility, discretionary trusts may entail certain disadvantages. Administrative complexities, including the need for meticulous record-keeping and trustee decision-making, can arise. Additionally, tax implications, such as the application of tax on trust income, may pose challenges. Moreover, legal costs associated with administering discretionary trusts can be substantial.
Nothing in this article constitutes any legal advice. This article only reflects the writer’s understanding of English law and how it operates.