In Short
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A discretionary trust allows the trustee to decide who benefits and by how much.
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A family trust is a type of discretionary trust where beneficiaries are typically family members.
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The terms are often used interchangeably, but a family trust may involve a family trust election for tax purposes.
Tips for Businesses
When considering a trust structure, consult with legal and financial professionals to ensure it aligns with your business goals and complies with regulations.
Table of Contents
- Family Trusts and Discretionary Trusts
- What Are Discretionary Trusts?
- What Are Family Trusts?
- Key Players Involved in a Trust
- Trust Deed
- Advantages of Discretionary Trusts
- Flexibility in Beneficiaries
- Disadvantages of Discretionary Trusts
- What Are Unit Trusts and How Are They Different?
- Frequently Asked Questions
A trust is a legal structure that allows one or more people (or companies) to manage property for somebody else’s benefit. Trusts are an excellent way to manage your tax and protect your assets. Likewise, owning your business through a trust offers many advantages. This article will explain the difference between discretionary and family trusts.
Depending on what the trust is for, the person for whose benefit the trust is for might receive:
- capital;
- income; or
- a combination of the two.
Family Trusts and Discretionary Trusts
Discretionary trusts and family trusts are often used interchangeably in practice. A discretionary trust is a type of trust where the trustee has the discretion to decide which beneficiaries receive distributions from the trust. A family trust is typically a discretionary trust established to hold family assets or manage a family business, with family members as the primary beneficiaries.
Generally, a family trust is a discretionary trust specifically established for the benefit of family members, allowing the trustee flexibility in determining how and when distributions are made.
What Are Discretionary Trusts?
Discretionary trusts are set up to allow the person or people managing the trust to choose:
- who can benefit from the trust; and
- how much money beneficiaries will receive.
Accordingly, the amount of money beneficiaries receive under a discretionary trust is not fixed, nor are the beneficiaries who may receive money from the trust. A discretionary trust will include named beneficiaries, as well as broader classes of beneficiaries, such as spouses, children, and companies related to the named beneficiaries. As such, the trustee has the discretion to choose who to make distributions to. Likewise, the trustee can determine the amount each beneficiary receives from year to year.
What Are Family Trusts?
Individuals usually set up family trusts as discretionary trusts that hold a family’s assets, which may include owning a family business. Usually, one or more family members will manage the trust assets for their family as a whole. While the trustee can choose who benefits from the trust, beneficiaries will only be family members since the trust is managed within the family.
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Key Players Involved in a Trust
The table below explains the key players involved in a trust.
| Role | Description |
| Settlor | This person sets up the trust. Usually, the settlor will be a lawyer or accountant. Once the settlor does their part in creating the trust, they generally have no further involvement. Therefore, the settlor cannot benefit from the trust. |
| Trustee |
This person is the legal owner of the trust property. The trustee decides how to manage the trust assets. Likewise, they make all decisions, choices and transactions relating to the property’s management. However, they do so in the interests of those benefiting from the trust. The trustee must act in the best interests of these people. The role of a trustee is something like the role of a company director. Directors must act in the best interests of the company and its shareholders. |
| Appointor | This person has the power to remove and nominate trustees. Usually, this will happen when a trustee passes away or otherwise cannot continue to manage the trust. The Appointor is usually the person who is the director of the corporate trustee of the trust. |
| Beneficiaries | These people benefit from the money or property in the trust. The beneficiaries do not have ownership over the trust assets. Still, they have the right to be considered when the trustee decides to distribute money or property from the trust. |
Trust Deed
This is the legal document that formally creates the trust and outlines how it will work. It will usually set out:
- the objectives of the trust fund;
- who the beneficiaries are;
- who the trustee and appointor is; and
- how income and assets will be distributed from the trust.
Advantages of Discretionary Trusts
People may choose to set up a trust for many different reasons. However, there are several business advantages of using discretionary trusts.
Asset Protection
A discretionary trust allows a person to hold onto their assets without being the legal owner of the property. This can have significant advantages.
For example, if a creditor pursued a beneficiary’s assets, the trust property is generally protected because the trustee is the legal owner rather than the beneficiary.
Tax Management
A company structure has to pay income tax on its net income every financial year. Discretionary trusts, however, generally do not have to pay income tax. Instead, the beneficiaries pay tax on their share of the trust’s net income. In a family trust, this means that the trustee can distribute assets to reduce the overall tax paid by the family.
Unlike companies, trusts may be eligible for the general 50% capital gains tax (CGT) discount on the disposal of capital assets.
Beneficiary Income
Discretionary trusts are a great way of providing income to beneficiaries who may be dependent or otherwise unable to manage their assets. For example, the trust can explicitly list the names of individuals that you wish to benefit from the trust. You can name the primary beneficiaries of your trust and also nominate unnamed beneficiaries. These unnamed beneficiaries can include the extended family of the named primary beneficiaries.
For example, the trustee can nominate for “the children from the marriage of John Smith and Jane Smith” (your unnamed primary beneficiaries) to be entitled to receive the trust income in the trust deed.
Flexibility in Beneficiaries
Both family and discretionary trusts allow for a broad class of beneficiaries, as the trustee’s discretion determines who benefits from the trust and how much they receive. This allows for flexibility in allocating assets as the trustee can include or exclude certain individuals or groups of people. This may include:
- family members;
- employees;
- charities; or
- companies.
In a family trust, the class of beneficiaries is typically restricted to family members, which can include spouses, children, grandchildren, and other relatives, depending on how the trust deed is drafted. This narrow focus helps to maintain control over the distribution of assets within the family unit. While this may limit the pool of potential beneficiaries, it offers the advantage of focusing wealth on the family’s long-term financial security.
Disadvantages of Discretionary Trusts
Even though a trust can offer many advantages, there are also some disadvantages to using trusts as a business structuring option.
Expense
Trusts can be quite costly to set up, administer and restructure, such as the following:
- stamp duty may apply to the trust depending on the state in which the trust is established;
- ongoing administration of the trust, including record-keeping, tax filings, and distribution decisions; and
- if the trust deed must be changed or restructured later on, there may be additional fees and resettlement costs.
Liability of Trustees
Trusts offer excellent asset protection for the beneficiaries. However, because trustees are the legal owners of the trust property, they are personally liable for any debts incurred by the trust. Having a company trustee rather than an individual can reduce this liability.
Growth and Investment
Investors tend to favour investing in company structures rather than trusts. Accordingly, it can be more challenging to grow a business that operates through a trust. However, there are ways around this. For example, you can set up a company to own and run your business, then own that company’s shares through a trust structure, alongside investors who hold shares directly in the company.
Retaining Profits
Unlike a company, trusts are not designed to keep any profits. If trust beneficiaries do not receive all profits, the trust assets will be heavily taxed.
What Are Unit Trusts and How Are They Different?
If you are considering setting up a discretionary trust, you may have encountered the concept of a unit trust. Unlike a discretionary trust, where the person managing the assets chooses how to distribute profits, a unit trust shares profits amongst the beneficiaries based on how many ‘units’ they have in the trust. As the name suggests, a discretionary trust gives the trustee considerable discretion in distributing profits. A unit trust has a much more fixed process.
Frequently Asked Questions
Discretionary trusts enable the person or persons managing the trust to determine who can benefit from the trust and how much money each beneficiary will receive.
Family trusts, as generally understood, are discretionary trusts that hold a family’s assets or run a family business. Typically, one or more family members will manage the trust assets for the benefit of the entire family.
A trust deed is a legal document that formally creates the trust. It also outlines the terms, rules, and conditions for creating and managing it. Typically, the trust deed outlines the objectives of the fund and identifies the beneficiaries. Likewise, it will detail how much beneficiaries are to receive and the method of payment. Importantly, the trustee must manage the trust’s assets in accordance with the trust deed.
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