When establishing either a discretionary trust or unit trust, it is important to know how each type of trust operates. The main distinction between a unit trust and discretionary trust is around how beneficiaries entitlements are determined under the trust and how this is distributed.
So what are the key differences?
With discretionary trusts the beneficiary’s entitlements are left to the discretion of the trustee, who chooses which beneficiaries receive trust distributions and how much.
A discretionary trust is often used within a family to help protect family assets or conduct a business, and the trust can make a ‘family trust election’ to take advantage of certain tax benefits by limiting the distribution pool to the family group.
The discretionary structure has the major benefit of flexibility in distributing income, as distributions can be directed to beneficiaries on lower marginal tax rates to minimise the overall tax paid. Other benefits include asset protection from creditors (but note the importance of having a corporate trustee) as the assets of a discretionary trust are separate to the assets of the beneficiaries, and the ability to carry forward losses in certain circumstances. The main disadvantages is that the trust cannot distribute outside of the family group without penalty, and the structure is “controlled” rather than owned.
Unit trusts are fixed trusts in that the beneficiaries receive distributions in proportion to the number of ‘units’ they hold. The trust allocates the units to beneficiaries for consideration, and units in the trust can be bought and sold between parties. Beneficiaries receive a set percentage of the income and/or the capital of the trust in accordance with their unit holding.
Unit trusts are similar to companies, in that much like companies have shareholders with fluctuating share prices, unit trusts have units with changing unit values, and unit holders make an initial contribution to the trust as investors.
Unit trusts benefit from simplicity – the units define exactly who is entitled to the distributions. This is generally more suitable when unit holders fall outside of one family group. Another benefit is that the units in the trust may be transferred to another beneficiary easily, or alternatively cashed in. Additionally unit trusts provide asset protection and are subject to far less regulation in comparison to a company. The main disadvantage is that unit trusts have less flexibility with income and capital distributions.
Overall discretionary trusts give the trustee far more choice in how to distribute profits, but unit trusts define ownership better. Choosing the best structure is unique to your circumstances and ultimately you’ll want to get some professional advice around this because getting it wrong at the start can cause a costly problem further down the track.
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Author: Danielle Pomersbach