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Discretionary Trust

A discretionary trust is a type of trust that can be established on behalf of one or more beneficiaries. The trustee who oversees the trust can use their discretion in determining when and how trust assets should be distributed to beneficiaries, hence the name. There are different reasons why you might consider establishing a discretionary trust in lieu of other trust options. Understanding the pros and cons of discretionary trusts can help you decide if creating one makes sense for your estate plan.

A financial advisor can help you sort through the myriad of estate planning options.

What Is a Discretionary Trust?

A trust is a legal arrangement in which assets are managed by a trustee on behalf of one or more beneficiaries. In a typical trust arrangement, assets are managed according to the directions and wishes of the trust creator or grantor. For example, you might specify that your children must wait until they graduate college or turn 30 before they can access trust assets.

A discretionary trust, on the other hand, allows the trustee to have full discretion when overseeing the distribution of trust assets to beneficiaries. The trustee has control over the trust assets, though they cannot use them for their own purposes as they’re still bound by a fiduciary duty. But this means that beneficiaries can’t make requests or demands of assets from the trust.

How Discretionary Trusts Work

Discretionary trusts are a type of irrevocable trust, meaning the transfer of assets is permanent. When someone creates a discretionary trust they can name a trustee and one or more successor trustees to oversee it. This person is typically someone the grantor can trust to use their discretion wisely in managing trust assets on behalf of the beneficiaries.

The grantor can set guidelines on when trust assets should be distributed and how much each trust beneficiary should receive. These guidelines can be as broad or as specific as you like. But again, it’s up to the trustee to decide what choices are made with regard to distributions of principal and interest from trust assets.

That doesn’t mean a trustee has absolute power, however. The trust grantor can also name one or more appointers. These individuals have the authority to remove the trustee and appoint a new one if it becomes apparent that the trustee is straying too far from the grantor’s wishes or has breached their fiduciary duty in some way.

What’s the Point of a Discretionary Trust?

Discretionary Trust

Discretionary trusts can serve an important purpose in estate planning. This type of trust can help to prevent mismanagement of assets on the part of beneficiaries. Say, for example, that you have an adult child who has a history of extravagant spending or running up debt. You could set up a discretionary trust to ensure that they still receive assets from your estate once you pass away without giving them free rein over those assets. Instead, your chosen trustee can use their discretion to decide when to make assets from the trust available to your child.

Discretionary trusts can also offer protection against creditor lawsuits. Going back to the previous example, say that your child defaults on one or more debts. If their creditors decide to pursue a civil judgment to collect what’s owed, assets in a discretionary trust would be protected. That’s because the trustee technically owns those assets, not the trust beneficiaries.

Discretionary trusts can also be used in other situations where you may have concerns over how trust assets will be used. For example, you may choose to create this type of trust if you’re worried about your married child getting divorced and their spouse attempting to lay claim to their share of your estate. Or you might consider this type of trust when you have minor children or special needs dependents who are incapable of making sound financial decisions.

How to Set Up a Discretionary Trust

Setting up a discretionary trust isn’t that different from creating any other type of trust. An estate planning attorney can help with the creation of a discretionary trust if you’re not sure what the process involves. When establishing the trust, you’ll need to decide:

  • Who to name as trustee and successor trustees
  • Whether to choose appointers and if so, who those individuals should be
  • Which assets will be transferred to the trust
  • Who to name as trust beneficiaries
  • Under what circumstances you’d like assets to be distributed to beneficiaries

Remember, this is an irrevocable trust so the transfer of assets is permanent. So it’s important to be sure beforehand that this type of trust is appropriate for your estate planning needs. It may be helpful to discuss other trust options with an estate planning attorney or a financial advisor before moving ahead with the creation of a discretionary trust.

Is a Discretionary Trust Right for You?

A discretionary trust could make more sense in certain financial situations than others and it’s important to consider both the pros and cons. As mentioned, the chief advantage of this type of trust is the ability to preserve assets for beneficiaries under the guidance and discretion of a trustee. This assumes, however, that the person you select as trustee will act to preserve your wishes as much as possible.

If the trustee abuses their discretion or deviates significantly from your wishes your beneficiaries may not receive assets as you intended. For that reason, it’s important to carefully consider who you name as trustee. Choosing a group of appointers can offer some reassurance that should the trustee need to be removed, there will be someone to take the necessary action to do so.

Aside from that consideration, it’s important to weigh the costs of establishing and maintaining a discretionary trust. Depending on the size of your estate, you may spend several thousand dollars in legal fees alone to have the trust created. You’ll also need to plan for maintenance costs as well as the fee that’s paid to the trustee.

Bottom Line

Discretionary Trust

Discretionary trusts can protect your beneficiaries from their own poor money habits while preserving a legacy of wealth for future generations. A properly structured discretionary trust could also yield some estate tax planning benefits. When considering this type of trust, it’s important to weigh the investment of time and money required to create and maintain one to decide if it’s worth it.

Estate Planning Tips

  • Consider talking to a financial advisor about whether a discretionary trust is something you might need. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • A trust is one element of a well-rounded estate plan; a last will and testament is another. Even if you have a trust in place, a will still serves an important purpose. For example, you can use a will to specify how any assets you own that aren’t included in a trust should be distributed. You can also use a will to name guardians for minor children. If you don’t have a will yet, it’s possible to create one online using will-making software. Or you could seek the help of an estate planning attorney if you have a more complex estate.

Photo credit: ©, © Burdun, ©

Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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