What is the difference between a fixed and a discretionary trust?

On Behalf of | Feb 2, 2024 | Estate Planning

A trust is a legal arrangement in which an individual, referred to as the grantor, transfers their assets into a trust managed by a trustee for the benefit of designated beneficiaries. The primary purpose of a trust is to provide a structured and efficient way to manage and distribute assets, avoiding the complexities and delays associated with probate.

If you’re considering establishing a trust, you can choose between a fixed and a discretionary trust. Understanding the differences between these two options can help you make the appropriate choice.

What is a fixed trust?

As the name suggests, a fixed trust has a predetermined distribution of income and capital among its beneficiaries. The key feature lies in each beneficiary’s fixed entitlement, which precisely outlines what share they are entitled to receive. This rigid structure provides a sense of certainty but may lack the flexibility seen in discretionary trusts.

However, since income distribution is predetermined, it offers a stable and predictable source of financial benefit for beneficiaries. This characteristic makes fixed trusts attractive for individuals seeking a reliable income stream.

Moreover, tax implications in a fixed trust are relatively straightforward. The fixed distribution structure often results in a more predictable tax outcome, making it easier for beneficiaries to plan and manage their tax liabilities.

What is a discretionary trust?

Unlike its fixed counterpart, a discretionary trust offers a higher degree of flexibility. The hallmark of a discretionary trust is the trustee’s discretion in distributing income. This allows for adjustments based on beneficiaries’ varying financial needs, tax implications and changing economic conditions.

Discretionary trusts often provide enhanced tax planning opportunities. Beneficiaries and trustees can optimize tax outcomes by strategically managing income and capital distributions, potentially minimizing tax liabilities.

When it comes to trusts, the choice between a fixed and discretionary trust hinges on individual preferences, financial goals and one’s desired level of control. Each structure has its merits, and understanding these distinctions can empower individuals to make informed decisions aligned with their unique circumstances.