What Does It Mean to Form a Discretionary Trust?

Creating a trust involves different decisions, such as whether to make your trust a revocable or irrevocable trust as well as determining who should benefit from your trust. If you are contemplating a trust for your children or other beneficiaries, you should also figure out whether to make your trust a fixed trust or a discretionary one.

If you are not familiar with the distinction between a fixed trust and a discretionary trust, the difference is simple to understand. According to The Motley Fool, what separates these two kinds of trusts is the power your trustee has to disperse benefits.

How a fixed trust works

When you create a fixed trust, you establish a formula for how your beneficiary will receive trust benefits. Say you set up a trust with an amount of $50,000. If you want a fixed trust, your trust will disperse specific amounts from that $50,000 to your beneficiary. You may also choose specific times when your beneficiary will receive funds. You will specify these requirements in the trust documents.

How a discretionary trust works

However, you may want your trustee to have more discretion in paying a beneficiary. For example, if you have a child who is struggling with drug addiction, you want your child to spend the trust money wisely and not on a drug habit. To that end, you may wish for your trustee to condition payouts on your child going to rehab and sticking with it.

To give your trustee more freedom to choose how and when to pay a beneficiary, you would make your trust a discretionary trust. With this type of trust, you set guidelines for how you want your trustee to act, yet your trustee retains the authority to determine how to carry out your wishes. As an added benefit, a discretionary trust may better protect the money of your beneficiaries from creditor claims.

Choose according to your priorities

There are different reasons to choose a fixed or a discretionary trust. Keep in mind that a discretionary trust may carry its own risks, particularly if your trustee does not heed your wishes. On the other hand, a fixed trust may not take into account changes in the lives of your beneficiaries, like a sudden decline in a beneficiary’s health. Make your decision according to your personal priorities for whoever you want to benefit from you.