This blog post is brought to you by: Fatima Husnain, Student-at-Law, at Fasken
Discretionary trusts are a tool used in estate planning to create a flexible trust that provides trustees the discretion to decide who receives the income or capital from the trust and when. The trustees must choose from the class of beneficiaries that are named in the trust, however, none of the beneficiaries have an automatic right to receive proceeds from the trust. There are many benefits to this type of trust and some drawbacks that can be overcome through proper estate planning.
Discretionary trusts can provide significant benefits to both the creator of the trust and the beneficiaries by first, allowing flexibility regarding distribution and second, providing the ability for the trustees to control the property while it is in trust.
First, a discretionary trust provides flexibility to determine how the property should be distributed at a future date. This can mean a bulk distribution or annual distributions to beneficiaries. Trustees can use the circumstances of the individual beneficiaries and the tax considerations at the time to determine if and when the trustees should make a distribution to the beneficiary.
Second, if the beneficiaries or the creator of the trust are also the (or one of the) trustees, then they can control how the property is managed while it remains in the trust. This allows for continued control of the estate assets even after the assets have moved into the trust. This ability can be especially useful to ensure that the trust assets are managed in a tax-efficient manner. The beneficiary or creator of the trust, as trustee, can control how the assets are used in the trust without having to distribute the assets. The creator of the trust specifically can use this tool to put their assets in a trust and remove them out of their personal estate and still retain control of how the assets are used and distributed.
The ability for trustees to have significant flexibility and control over the trust makes discretionary trusts a very useful and effective estate planning tool.
Although there are significant benefits to discretionary trusts, there are some drawbacks that are important to consider. First, the potential for various tax implications to arise in relation to the trust, and second, this trust method could provide too much autonomy to trustees.
First, attribution rules under the Income Tax Act could be triggered if the trust is created improperly. As with all trusts and estate planning tools, tax considerations play a significant role in the creation and management of a trust. In order to avoid any attribution rules under the Income Tax Act the settlor of the trust cannot also be a beneficiary of the trust. If property is distributed from the trust to someone that provided property to the trust, the attribution rules would apply. The attribution rule would also apply if the individual contributing property to the trust is the only person (or has majority) in determining how the property is distributed. There are additional tax considerations such as residency of the beneficiaries that can create significant tax repercussions.
Second, the trustees are afforded significant power and flexibility to make decisions as they see fit. It is therefore imperative that the creator of the trust has confidence in the trustee(s). One way to minimize the potential for an unscrupulous trustee is to require a minimum of three trustees and provide for majority decision making mechanism to ensure no individual trustee has unchecked decision making power.
Although there are potential drawbacks to discretionary trusts, there are tax and estate planning techniques to reduce the impact or avoid the drawbacks. If you are considering creating a discretionary trust or are a trustee to a discretionary trust, it is recommended that you seek legal advice to ensure that no other tax rules are triggered and the trust is used to its full potential.