discretionary trust

Definition of discretionary trust

Further reading

A discretionary trust is [1] is a trust where the beneficiaries and/or their entitlements to the trust fund are not fixed, but are determined by the criteria set out in the trust instrument by the settlor. Where the discretionary trust is a testamentary trust, it is common for the settlor to leave a letter of wishes for the trustees to guide them as to the settlor's wishes in the exercise of their discretion. Letters of wishes are not legally binding documents.

Discretionary trusts can only arise as express trusts. It is not possible for a constructive trust or a resulting trust to arise as a discretionary trust.

Discretionary trusts can be discretionary in two respects. First, the trustees usually have the power to determine which beneficiaries (from within the class) will receive payments from the trust. Second, trustees can select the amount of trust property that the beneficiary receives. Although most discretionary trusts allow both types of discretion, either can be allowed on its own. It is permissible in most legal systems for a trust to have a fixed number of beneficiaries and for the trustees to have discretion as to how much each beneficiary receives,[2] or to have a class of beneficiaries from whom they could select members, but provide that the amount to be provided is fixed.[3] Most well-drafted trust instruments also provide for a power to add or exclude beneficiaries from the class;[4] this allows the trustees greater flexibility to deal with changes in circumstances (and, in particular, changes in the revenue laws of the applicable jurisdiction).

Characteristically, discretionary trusts provide for a discretionary distribution of income only, but in some cases the trustees also have a power of appointment with respect to the capital in the trust, i.e. the corpus.

Discretionary trusts are usually sub-divided into two types:

• exhaustive, where the trustees must distribute all income accruing to the trust fund; and
• non-exhaustive, where the trustees have a power to accumulate income.

Footnotes

1. Sometimes referred to as a family trust in Australia
2. Although in many jurisdictions such a trust would be characterised as a fixed trust with a discretionary power of appointment
3. A common example is a scholarship set up by way of a trust fund
4. See Re Manisty's Settlement [1974] Ch 17 and Blausten v IRC [1972] Ch 1 256