Discretionary Trusts and Beneficiary Entitlements

The establishment of a Trust creates a relationship between a Trustee and the Beneficiaries of the Trust, in which the Trustee is under an obligation to hold property for the benefit of the Beneficiaries.

The Trust Deed sets out the terms of the obligation and establishes the Trustee as the legal owner of the Trust property, with the Beneficiaries holding a beneficial rather than proprietary interest in the Trust property.

In a Discretionary Trust the Beneficiaries do not have a fixed entitlement or interest in the Trust property. Rather the Trustee has the discretion to determine the nature, extent and recipient of any distribution of the capital and/or income of the Trust.

The Trustee’s discretion is not absolute. The Trust Deed sets out the Beneficiaries within a nominated class to whom the Trustee can distribute.

As a general rule, Beneficiaries will not have an interest in the Trust property until an entitlement is created by the Trustee. That entitlement, often referred to as a ‘present entitlement’, can either be distributed or retained in the Trust for investment or other purposes. If retained, it is referred to as an ‘unpaid present entitlement’.

The advantage of the Trustee being able to exercise discretion in relation to the distribution of Trust capital and income is the flexibility it affords the Trustee and the Beneficiaries.

Care should be taken however when dealing with Beneficiary entitlements to ensure the dealings are properly recorded in the Trust accounts and legally effective as well as tax effective. While seemingly obvious, taking such simple steps can help the Trustee to avoid potential adverse consequences should there be a breakdown in the relationship between the Trustee and the Beneficiaries, or when a Beneficiary faces demands from its creditors.

Strategies such as forgiving or releasing beneficiary entitlements, in appropriate cases, can also be utilized to mitigate risk.

While Discretionary Trusts offer the benefits of asset protection, tax savings and greater flexibility in estate planning, making sure the Trustee deals with Trust property properly is vital.

Regardless of whether you are a Trustee, or a Beneficiary of a Discretionary Trust, if you are at all uncertain as to the efficacy of any proposed dealings with the property of your Trust, we recommend that you take the time to discuss the practical, and legal issues you will need to consider with us, before giving the Beneficiaries entitlements to trust income or property.

For further enquiry, please contact us.