Discretionary Trusts and Asset Protection – Common Questions
A discretionary trust is a trust where the trustee has discretion in choosing which beneficiaries will receive income or assets from the trust, and how much they will receive. Of course, the trustee must comply with the rules of the trust deed and classifications of beneficiaries. A discretionary trust can be used as a standalone trust, form part of an estate planning strategy, or be used in business structuring. In each of these scenarios, discretionary trusts can provide significant advantages in terms of asset protection, tax optimisation and estate planning. The efficiency of a discretionary trust in terms of these advantages will depend on a range of circumstances.
We have put together answers to a few common questions that we hear about using discretionary trusts for asset protection.
How can a discretionary trust protect assets?
The trustee of assets held in a discretionary trust is the legal owner of the assets. Usually, beneficiaries of discretionary trusts only have a contingent rather than proprietary interest the trust assets. Until a distribution is declared, they are ‘mere discretionary objects’ as the trustee can choose who to distribute assets to amongst the beneficiaries. This means that if a beneficiary goes bankrupt, this is unlikely to affect the assets of the trust so long as the trustee is a separate person or company. In this case, the trustee could choose not to distribute any assets to the bankrupt individual.
The situation will be different if a trustee declares a distribution to a beneficiary and the amounts have not been paid. In this instance, the beneficiary will have an interest in the unpaid distributions. Thus, if a beneficiary went bankrupt after a distribution was declared, the unpaid distribution would vest in the trustee in bankruptcy.
If someone could be at risk of bankruptcy, they should not become a trustee of a discretionary trust. If a trustee becomes bankrupt, difficulties could arise in proving that the assets were assets by the trust rather than assets owned by the bankrupt in their personal capacity.
Should I use a corporate trustee?
Using a corporate trustee can assist with asset protection by limiting the trustee’s liability to the corporate entity. Usually corporate trustees have negligible assets. Unlike an individual, a corporate trustee can exist indefinitely. The corporate trustee can be controlled by shareholders appointing directors. Legal ownership of the trust assets will not change with the directors and shareholders. Problems can arise if a bankrupt person owns shares in the corporate trustee. If an at-risk person is to own shares in a corporate trustee, they should only own a minimal amount.
What are default capital and default income beneficiaries?
Default capital and default income beneficiaries are entitled to the income or capital of the trust if the trustee does not make a decision by the deadline to distribute income or capital. Unlike a normal beneficiary, default beneficiaries are considered to have an interest in the trust assets. Therefore, if a default beneficiary goes bankrupt, the assets of the trust could be at risk. For this reason, an individual should not be a default beneficiary if they are at risk of bankruptcy.
What is an appointor?
Most discretionary trusts provide for an ‘appointor.’ An appointor is a person who has the power to remove the trustee. Some trust deeds will provide additional powers, such as consenting to amendments in the trust deed. For asset protection purposes, it is important that the trust deed is drafted so that it is clear that the appointee’s powers are personal, rather than proprietary powers that would provide them with an interest in the trust assets. One way of doing this is allowing for two appointors who must make decisions jointly. It is also important to note that a beneficiary will be the owner of the trust property if they are also the trustee or they have the power to appoint a new trustee.
Are you considering using a discretionary trust to protect your assets? Wondering how a discretionary trust could fit into your estate planning strategy or business structuring plans? Please don’t hesitate to contact our experienced Newcastle commercial lawyers at Butlers Business and Law on (02) 4929 7002 or fill out an enquiry form on our website.