What Is It?
A Discretionary Trust is another type of trust that is commonly used by a grantor seeking to distribute assets to a class of people or their family. Unlike a mandatory trust which requires distributions of income and principal be made according to a set schedule that is executed in the trust document, discretionary trusts allow the trustee to make determinations about when and how much beneficiaries are to receive in capital and income from the trust. Beneficiaries of discretionary trusts do not have entitlement to a specific interest in the trust, they have a right to be considered for the appointment of property or income from the trust
When and Why To Use a Discretionary Trust
Discretionary trusts versus mandatory trusts are used by grantors for a number of reasons, but are commonly used to help provide for vulnerable family members, such as those with disabilities or those who are incapacitated and cannot care for themselves, as well as young children. In both of these situations, it can be difficult to assess the needs of the disabled individual or the child and allows the grantor to outline various situations and adapt based on the beneficiary’s circumstances and age, among other factors. Thus, there is a significant level of flexibility when it comes to how these trusts are administered.
Additionally, there may be tax benefits to holding a discretionary trust for an individual. Individuals are provided a 50% from capital gains taxes as applied to discretionary trusts, however this only applies if the beneficiaries are people, not corporations. Lastly, this type of trust can can block creditors who seek to come after the assets of a beneficiary. Due the lack of control that the beneficiary has with these trusts, creditors are prohibited from reaching the potential distribution a beneficiary may receive.
There are, however, some potential downfalls to this type of trust. Due to the immense amount of discretion and control a trustee is given as compared to trustees administering mandatory trusts, there is substantial potential for abuse by those administering the trust. Grantors must use great discretion when determining who will be best suited to execute their wishes. Additionally, this discretion can sometimes result in unequal allocation of the income distributed, depending on the beneficiary’s relationship with the grantor. These potential negative aspects can be mitigated by heavily vetting who will be appointed trustee and also having checks in place to ensure that the trustee stays in line with what the grantor wanted.