What is a discretionary trust?
A discretionary trust is a type of trust where the trustee has the authority to decide the amount and timing of distributions to beneficiaries based on specific criteria or circumstances.
Key takeaways
- Discretionary trusts are unique in that they give trustees the discretion to make decisions on distributions, tailoring them to the specific needs and circumstances of the beneficiaries.
- Discretionary trusts are an optimal choice for asset protection because by relinquishing control over the trust to a trustee, it makes it difficult, if not impossible, for creditors to access the trust’s assets.
- Despite their asset protection benefits, potential pitfalls may arise due to the extent of the trustee’s discretion.
Discretionary Trusts Distinguished from Other Forms
Trusts come in various forms, each designed to serve specific purposes, needs, and levels of asset protection. Some of the common types include:
- Discretionary Trusts: Discretionary trusts give the trustee the authority to decide the amount and timing of distributions based on specific criteria or circumstances. From an asset protection standpoint, discretionary trusts offer excellent protection. Since there's no guaranteed distribution, it's challenging for creditors to make claims against the trust assets.
- Fixed Trusts: The beneficiary receives a predetermined amount or percentage at set intervals. This type of trust offers predictability but may lack flexibility in responding to changing beneficiary needs. Regarding asset protection, fixed trusts provide limited protection since creditors can potentially target the predefined distributions.
- Hybrid Trusts: These trusts combine features of both discretionary and fixed trusts. For instance, a hybrid trust might specify that beneficiaries receive a fixed amount annually but also allow the trustee to make additional discretionary distributions for specific needs like education or medical emergencies. The scope of asset protection with these trusts will depend on the specific terms and conditions set by the settlor.
- Contingent Trusts: Distributions to beneficiaries are contingent upon specific conditions or events. For instance, a beneficiary might only receive distributions upon reaching a certain age or achieving a particular milestone, like graduating from college. Asset protection in contingent trusts is variable; while the assets remain in the trust and conditions are unmet, they are generally protected from creditors. However, once conditions are met and distributions are due, those assets can become vulnerable to creditor claims.
Criteria for Discretionary Disbursements
The fact that the trustee has discretion over how and when distributions should be made means that the discretion is meant to operate within certain parameters and predefined conditions that will usually be stated in the trust documents, and may include:
- Educational expenses such as tuition, books, and other related costs.
- Healthcare needs, including fees associated with medical treatments, health insurance, and medications.
- Family emergencies, such as unforeseen events like accidents or natural disasters which necessitate immediate financial support.
- Living expenses, including costs for basic necessities such as housing, food, and transportation.
- Funds to pursue investment opportunities and business ventures.
Challenges with Trustee Distributions in Discretionary Trusts
One of the primary challenges associated with discretionary trusts revolves around trustee distributions. In an ideal world, the trustee will adhere to the parameters set for them and make distributions that reflect the settlor’s intentions. However, circumstances may arise where a trustee might inadvertently favor one beneficiary over another or otherwise fail to comply with their discretionary duties, which can undermine the trust's primary objectives and prevent the beneficiaries from receiving the distributions per the settlor's original intentions.
