What is a discretionary trust?

A discretionary trust is a type of trust where the trustee is given discretion in relation to the distribution of monies to the beneficiaries. This discretion includes whether or not monies are distributed, and if so, how much each beneficiary receives.

What are the benefits?

It is no secret that there are benefits to a discretionary trust. Benefits of a discretionary trust include:

  • the ability to obtain tax benefits;
  • the ability to protect assets against creditors; and
  • the ability for succession planning.

How can it help me reduce tax?

For the purpose of this article, we’ll focus on the tax benefits of a discretionary trust. This article is not tax advice – it is best to obtain your own accounting and tax advice that applies to your business’s circumstances.

A discretionary trust is used by some individuals as a tax rate arbitrage tool.

This is best explained using an example.

Let’s suppose you are a middle-aged man with a high-income of $250,000 p.a., falling well within the highest tax bracket. You also have a wife who works as a clerk and earns $60,000 p.a. and 3 kids who each have part time jobs but are not making significant amounts of money.

You’ve got a sum of money saved up and you want to invest in some shares.

You decide to set up a discretionary trust which holds shares and other investments. When you start obtaining returns on these shares and investments, these returns go into the trust as trust money. If you set yourself up as the trustee of the discretionary trust, it is at your discretion what you do with that money and how it is distributed.

If you distribute money from the trust to yourself, it will be taxed in the highest tax bracket so you probably wouldn’t want to do that. You can distribute this money to your wife and your children, and as they are on lower incomes, they will be taxed at significantly lower tax rates.

Conclusion

This article is not taxation advice, and while there are benefits to setting up a discretionary trust, it is not suited for every person and every financial circumstance. To determine the best way to set up a business or arrange your finances, you should consult with relevant professionals. This may include a lawyer, an accountant or a tax adviser.

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