A trust structure will exist where a trustee (either an individual or company) is given the responsibility to hold property for the benefit of beneficiaries and to distribute the income or capital of a trust fund to the beneficiaries.
The most common types of trust structures are:
- discretionary trusts; and
- unit trusts.
A discretionary trust is a trust structure comprised of the trustee, appointor, and one or more beneficiaries. Discretionary trusts also known as trading trusts are commonly used by families to distribute income from an asset or enterprise to one or more beneficiaries. Unlike a unit trust, the beneficiaries in a trust structure do not have a fixed entitlement/right to receive a distribution from the trust.
Benefits of Discretionary Trusts
The advantages of discretionary trusts include:
- Asset protection from creditors. Beneficiaries of a discretionary trust do not have a fixed entitlement to receive a distribution from the trustee. This means that creditors are not able to seize a beneficiary’s interests in a trust to satisfy any debts which may be owed by a beneficiary (should a beneficiary become bankrupt).
- Flexibility in the distribution of income. The trustee decides when payments from the trust funds should be made, and to whom. Hence, the tax thresholds that apply to an individual can be used. Therefore, the trustee can maximum income splitting opportunities to minimise taxable income.
- The right to receive a distribution from the trust fund is not inheritable. This is because the beneficiary does not have a defined interest to receive any payment (either income or capital) from the trustee. This may be advantageous to those who wish to restrict distributions to a specific person or individual within a generation.
Disadvantages of Discretionary Trusts
The disadvantages of discretionary trusts include:
- A trustee’s decision to make an income payment to some beneficiaries over others may be challenged by a beneficiary. This is because the trustee must make a decision to distribute income or capital from a trust fund, and may do so to some individuals over others.
- A discretionary trust may be difficult and time consuming to administer as the trustee needs to consider the tax thresholds of each individual, and the timing of a distribution.
Benefits of Unit Trusts
The advantages of unit trusts include:
- Certainty, as the unit holder/beneficiary will receive a distribution from the trust fund which is commensurate with that person’s unit holdings in the trust structure. This is important for a unit holder or investor who pays, or has paid a subscription fee in return for a right to receive income from the trust fund.
- New investors are able to be admitted into the trust structure by way of subscription.
Disadvantages of Unit Trusts
The disadvantages of unit trusts include:
- Creditors and spouses of a unitholder may be able to access a beneficiary’s entitlement to receive a capital or income distribution based on the unitholder’s entitlement. This is because a beneficiary’s interest in a unit trust is fixed i.e. distributions are based on the number of units held.
- Lack of flexibility in distribution. The flexibility which applies to a discretionary trust does not apply as each unit holder has a right to receive a distribution which is proportionate to the number of units held in that trust structure.
- Unit trusts are able to be inherited. Units held by a unitholder may be passed on by way of a will as such units would form part of the unitholders’ estate.
As set out above, it is important to note the advantages and disadvantages associated with each type of trust structure. Discretionary trusts are most commonly used by families, and are sometimes called family trusts, while unit trusts tend to be used in the context of a commercial investment venture.
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Key words: discretionary trusts, unit trusts, executors, beneficiaries, asset protection and income splitting