Fixed and Discretionary Trusts
Fixed trusts are an established form of living trust for estate planning. They enable the settlor to control money and assets for the benefit of the trust’s beneficiaries. Beneficiaries of a fixed trust receive trust property on a specific schedule set forth by the settlor. The trustee of a fixed trust has little or no discretion to distribute trust property. He or she cannot change the beneficiaries or the benefits they are set to receive.
The most common type of fixed interest trust is a life interest trust, under the terms of which one individual will have a right to all of the trust’s income during his or her lifetime. On this individual’s death, the trust property will generally be payable to named capital beneficiaries. Another type of fixed trust is one contingent upon the beneficiaries satisfying certain conditions, such as reaching a certain age. Once the expressed condition is satisfied, the beneficiaries will typically have an absolute interest in the capital.
The settlor may also choose multiple beneficiaries and provide a fixed benefit or percentage for each of his or her beneficiaries. For example, the settlor may grant 70% of the trust’s benefits to a spouse and 30% of the trust’s benefits to a child. Or the trust may be established for a handicapped child to ensure that he or she is properly cared for if the child’s parents or guardians die. The trustee is bound to make a distribution to the beneficiaries in this predetermined manner as set out in the trust deed. The beneficiaries have an interest in possession under the trust, subject to a deduction of sums paid by the trustees in the exercise of their administrative management powers.
A discretionary trust is like a fixed trust for which the settlor does not set fixed beneficiaries or trust interest amounts. The trustee of a discretionary trust has the power to decide which beneficiaries will benefit from the trust. He or she also has the right to decide the extent of its benefits. Although most discretionary trusts allow both types of discretion, either can be allowed independently of the other.
A well-drafted discretionary trust allows the trustee to add or exclude beneficiaries from the class, giving the trustee greater flexibility to address changes in circumstances. The trust is discretionary because the trustee has the discretion to give or deny some benefits under the trust. The beneficiaries cannot compel the trustee to use any of the trust property for their advantage.
Depending on the terms of the trust-creating instrument, income can be generated for future distributions to the beneficiaries or added to the body of the trust for the benefit of the remainderman, who is entitled to the remaining balance of the estate. Unlike a fixed trust, a discretionary trust gives the beneficiaries no hope for any residue or title of ownership to the trust itself.
The beneficiaries have no interests that can be transferred or reached by creditors unless the trustee decides to pay or apply some of the trust property for the benefit of the beneficiaries. At that point, the beneficiaries’ creditors can reach it unless it is protected by a spendthrift clause.
Discretionary trusts are more common than fixed trusts. Today, most family trusts are discretionary.