Key Takeaways

  • A fixed trust gives beneficiaries a predetermined share of trust assets, leaving the trustee little or no discretion.
  • A discretionary trust allows trustees to decide who benefits, how much, and when, providing greater flexibility.
  • Fixed trusts are often used for estate planning and situations requiring guaranteed support, such as for dependents with special needs.
  • Discretionary trusts are commonly chosen for asset protection, tax planning, and flexibility in changing family or financial circumstances.
  • Trust deeds can sometimes combine features of both fixed and discretionary trusts.
  • Tax treatment, beneficiary rights, and trustee powers differ significantly between the two types of trusts.

Fixed trust vs discretionary trust: A fixed trust, also known as a discretionary trust, determines the amount and terms of each beneficiary's share at the beginning. A discretionary trust lets the trustee or trustees make decisions about who becomes a beneficiary and how much each beneficiary gets.

Fixed trusts are common when a handicapped child is involved, to provide proper care for the child in the event the parents or guardians pass away. Discretionary trusts, however, have become more common than fixed trusts, and the majority of family trusts are discretionary. In some cases, a trust deed can be used to create a trust that's both fixed and discretionary.

What Is a Trust?

A trust is formed as a legal relationship when one person, the settlor, gives control of his or her assets under another with the goal of achieving a specified purpose or benefiting another person or people, called beneficiaries.

  • The other party involved is called the trustee.
  • The settlor's assets are transferred to the trustee, becoming the property of the trustee.
  • In spite of becoming the owner of the assets, the trustee must keep the assets on trust for the benefit of the beneficiaries. This makes the trustee the nominal owner of the assets.
  • Many times, more than one trustee is assigned.
  • There are also times when a trust has more than one settlor.

Fixed Trusts for Estate Planning

A fixed trust is a kind of living trust that's established for the purpose of estate planning. A fixed trust gives the settlor a way to control assets and money to be sure the trust's beneficiary benefits. A fixed trust's beneficiary gets property from the trust on a schedule the settlor establishes. The trustee gets little or no discretion in the distribution of the property that's tied up in the trust. The trustee can't change who the beneficiaries are or how much they are scheduled to get.

Advantages and Disadvantages of a Fixed Trust

Advantages:

  • Predictable: Beneficiaries know exactly what they will receive.
  • Certainty: Trustees have little room to deviate from the trust deed.
  • Useful for special needs planning, ensuring consistent care.

Disadvantages:

  • Inflexibility: Trustees cannot adapt distributions to changing financial or family circumstances.
  • Potential tax inefficiency: Income must often be distributed even if not tax-advantageous.
  • Limited protection: Beneficiaries’ fixed entitlements may be exposed to creditors.

Benefits of Using Trusts in Estate Planning

Trusts, whether fixed or discretionary, play an important role in estate planning. They can:

  • Avoid probate by transferring assets directly to beneficiaries.
  • Provide privacy since trusts are not always part of public court records.
  • Offer potential tax benefits by managing distributions strategically.
  • Protect vulnerable beneficiaries, such as minors or individuals with disabilities, from mismanaging assets.
  • Ensure long-term control over how and when assets are distributed.

Life Interest Trusts

A life interest trust is the most-often used fixed trust. The terms of a life interest trust give one individual the right to all of income from the trust during that person's lifetime. When the beneficiary of a life interest trust dies, the remaining trust property is payable to the named capital beneficiaries of the trust.

Conditional Trusts

Trusts can also be contingent on certain conditions being satisfied by the beneficiaries. Reaching a specific age is one common condition. When the condition indicated in the trust is achieved, the beneficiary usually has full interest in the property. Instead of a single beneficiary, multiple beneficiaries can be assigned by the settlor. The settlor can also assign either a fixed amount or percentage of the assets to each beneficiary.

  • For example, the settlor could assign 70 percent of the trust to a spouse and 30 percent to a child, or the trust could be established to provide care for a handicapped child.
  • The trustee has to distribute the predetermined amounts to the beneficiaries based on the terms established in the trust deed.
  • The beneficiary or beneficiaries have a legal interest in the trust's assets, minus deducted sums the trustees pay in the course of administering the trust.

When to Use a Fixed Trust

A fixed trust is most suitable when:

  • The settlor wants certainty in how wealth is divided.
  • There is a need to provide lifelong support for a dependent, such as a child with disabilities.
  • Family dynamics are stable, and future disputes are unlikely.
  • The settlor values predictability over flexibility.

In contrast, situations involving business succession, tax planning, or family members with varying financial needs often favor a discretionary trust.

Discretionary Trusts

Discretionary trusts are similar to fixed trusts, but the settlor doesn't assign a fixed beneficiary or beneficiaries. The trust interest amounts of beneficiaries are not set by the settlor in a discretionary trust. With this type of trust, the trustee makes the decisions as to who the beneficiaries will be and how much they will get. Most discretionary trusts let the trustee choose the beneficiaries and amounts, but it's possible to set one up to let the trustee choose only one aspect of the trust.

The trustee has more flexibility to adjust terms of the trust to changed circumstances with a discretionary trust that's been carefully drafted. This extends to adding beneficiaries and excluding them. The beneficiaries can't force the trustee to do anything to their benefit, and that's what makes it discretionary. The trustee can deny or provide the trust's benefits at will.

Key Features of a Discretionary Trust

  • Trustees can decide who receives distributions, in what amounts, and at what times.
  • Beneficiaries do not have a fixed entitlement; they only have a potential interest.
  • Provides asset protection since beneficiaries’ creditors cannot easily claim against the trust.
  • Offers flexibility to respond to changes in tax law, family size, or beneficiary needs.
  • Commonly used in family wealth planning to keep control centralized while meeting diverse needs

Advantages and Disadvantages of a Discretionary Trust

Advantages:

  • Flexibility in adjusting distributions.
  • Asset protection against creditors, divorces, or poor financial management.
  • Potential for income tax planning by distributing income to beneficiaries in lower tax brackets.

Disadvantages:

  • Beneficiaries have no guaranteed entitlement, which can cause disputes.
  • Trustees have significant responsibility and potential liability.
  • Administration can be more complex and costly than fixed trusts.

Frequently Asked Questions

  1. What is the main difference between a fixed trust and a discretionary trust?
    A fixed trust guarantees beneficiaries a set share, while a discretionary trust gives trustees power to decide who benefits and by how much.
  2. Can a trust be both fixed and discretionary?
    Yes. Some trust deeds blend both features, allowing certain beneficiaries fixed entitlements while others are subject to trustee discretion.
  3. Which type of trust is better for asset protection?
    Discretionary trusts generally provide stronger protection because beneficiaries do not have fixed entitlements that creditors can claim.
  4. Are fixed trusts still common today?
    Fixed trusts are less common than discretionary trusts but remain useful in estate planning where certainty and guaranteed distributions are important.
  5. How do taxes differ between fixed and discretionary trusts?
    Fixed trust income is usually taxed in the hands of beneficiaries, while discretionary trust income may be distributed strategically for tax efficiency.

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