The Benefits of a Discretionary Trust in Estate Planning

A discretionary trust — frequently called a family trust — is one of the most versatile and powerful tools available in Australian estate planning. This article explains what a discretionary trust is, distinguishes between inter vivos and testamentary trusts, and sets out the principal benefits of incorporating a trust structure into your estate plan.

What is a Discretionary Trust?

A discretionary trust is a legal arrangement under which a trustee holds property on behalf of a defined class of beneficiaries, with a discretion as to how the income and capital of the trust are to be distributed among them from time to time. Unlike a fixed trust — where each beneficiary has a fixed entitlement — a discretionary trust allows the trustee to determine in each income year how much (if anything) each beneficiary receives.

The trustee may be an individual or a corporate trustee. Corporate trustees are generally preferred for ongoing trusts because they have perpetual existence and provide an additional layer of asset protection.

Inter Vivos Trusts and Testamentary Trusts

Discretionary trusts arise in two principal contexts in estate planning:

• An inter vivos (or living) trust is established during the lifetime of the settlor by a trust deed, funded by the transfer of assets into the trust. The trust operates during the settlor’s lifetime and continues after their death if the trust deed so provides.
• A testamentary trust is a trust established by a Will that comes into operation only upon the death of the will-maker (testator). Assets are transferred into the trust from the deceased estate, rather than during the testator’s lifetime.

Both forms offer substantial benefits, though testamentary trusts have particular advantages in certain situations. The two types are not mutually exclusive; a comprehensive estate plan may incorporate both.

Asset Protection

Asset protection is one of the primary reasons clients establish discretionary trusts. Assets held within a properly structured discretionary trust are not owned by any individual beneficiary; they are owned by the trustee in its capacity as trustee. This means that:

• Creditors of a beneficiary generally cannot have recourse to trust assets in satisfaction of a personal debt, as the beneficiary has no fixed entitlement to those assets.
• A divorcing or separating spouse of a beneficiary cannot automatically claim an interest in trust assets on the basis that they form part of the beneficiary’s property, though courts have a wide discretion under family law to take trust assets into account in property settlements.
• Assets held in a testamentary trust created by your Will may be protected from the claims of a beneficiary’s future creditors, providing a level of security that a direct inheritance cannot achieve.

Tax Efficiency

Income generated by a discretionary trust can be distributed among beneficiaries in the proportions that best minimise the overall family tax liability, a strategy known as income splitting. Because the trustee has a discretion as to how income is allocated in each year, distributions can be directed to beneficiaries on lower marginal tax rates — such as adult children in lower income brackets.

In addition, testamentary trusts hold a particular tax advantage under the Income Tax Assessment Act 1997 (Cth): income distributed to minor beneficiaries (under eighteen years of age) from a testamentary trust is taxed at adult rates, rather than at the penalty rates that ordinarily apply to minors receiving trust distributions from inter vivos trusts. This can produce material tax savings in families where children are beneficiaries.

Flexibility and Adaptability

A discretionary trust is inherently flexible. The trustee can respond to changing circumstances by varying distributions from year to year in light of each beneficiary’s needs and tax position. Subject to the terms of the trust deed, it may also be possible to add new beneficiaries (for example, grandchildren not yet born) or to change the class of eligible beneficiaries.

The trust deed can be drafted to include detailed guidance from the settlor or testator as to how they would like the trustee to exercise their discretion, without creating a legally binding obligation that might defeat the asset protection purposes of the structure.

Probate and Estate Administration

Assets held in an inter vivos discretionary trust do not form part of the deceased’s estate and do not need to pass through the probate process. This can simplify and accelerate the administration of the estate, reduce legal and executor costs, and keep the distribution of those assets private.

Where confidentiality is important — for example, where the will-maker wishes to make specific provision for a beneficiary without this becoming publicly known — an inter vivos trust can achieve a degree of privacy that a Will cannot.

Family Wealth Across Generations

Discretionary trusts can be structured to preserve family wealth across multiple generations. By directing assets into a trust rather than distributing them absolutely to beneficiaries, a testator can ensure that the capital remains available to support the family as a whole, rather than being dissipated by individual spending or depleted by relationship breakdowns.

The trust deed may provide for the trust to continue for a specified number of years, until a defined event, or for the maximum period permitted by law, with capital ultimately being distributed to a class of beneficiaries chosen by the trustee or specified in the deed.

Important Considerations

Despite their considerable advantages, discretionary trusts are not a universal solution. They involve establishment costs, ongoing compliance obligations, and the need for a trustee who is willing and able to exercise the trust’s discretions carefully and responsibly over what may be many years. Poorly structured or poorly administered trusts can give rise to disputes and adverse tax consequences.

It is also important to note that the asset protection advantages of a trust may be reduced or eliminated if assets are transferred into the trust for the purpose of defeating the claims of existing creditors. Any advice to establish a trust should be sought from a qualified legal practitioner acting in your interests, not in the interests of any potential future creditor.

Want to Find Out More?

This article examines the benefits of discretionary trusts in estate planning. At Genders and Partners, Adelaide’s oldest law firm, we regularly advise clients on the establishment of testamentary and inter vivos discretionary trusts as part of a comprehensive estate plan.

When it comes to Wills, Probate, Deceased Estates, asset protection and estate planning in Australia, you can trust the oldest law firm in South Australia – Genders & Partners – to guide you through the tough decisions to create the best solution for your individual needs.

If you have any questions or would like further information, or a quick phone call to discuss, book a timeslot for a free 15-minute phone consultation.

We can help you to protect yourself and your family. We look forward to being of service.

More Resources on Trusts and Estate Planning

• What Are Testamentary Trusts?
• Estate Planning Trusts: How They Can Protect You and Yours
• Common Mistakes with Your Discretionary Family Trust
• Wills and Estate Planning FAQs
• Update Your Will and Estate Plan in Adelaide

All these and many more related topics are available for discussion with the oldest law firm in South Australia. Visit the Genders and Partners article library for further reading.

DISCLAIMER:  This article provides general information only and does not constitute legal advice. It does not address trust account matters or recommend asset protection strategies designed to defeat the claims of existing creditors. Tax considerations referred to are general in nature; specific advice from a registered tax agent or specialist is required. The law referred to is that of South Australia (Succession Act 2023 (SA), commenced 1 January 2025) and the Commonwealth (Income Tax Assessment Act 1997). Readers should obtain advice from a qualified legal practitioner before acting.