Unit trust vs discretionary trust – they sound pretty similar, don’t they? But they’re actually quite different. And knowing which one’s right for you can make a huge difference in how you protect your assets and plan for the future.
In this guide, we’ll cover unit trust and discretionary trust in detail, explore the ins and outs, and highlight their unique features and benefits. By the end, you’ll have a clear understanding of which trust structure aligns with your goals and circumstances.
What are Unit Trusts and Discretionary Trusts?
When it comes to managing your assets, trusts can be a powerful tool. But with so many different types of trusts out there, it can be tough to know which one is right for you. Two of the most common types are unit trusts and discretionary trusts.
So, what exactly are these trusts and how do they work? Let’s break down ‘Unit trust vs discretionary trust’ in simple terms.
What are Trusts?
A trust is a legal arrangement where one party, known as the trustee, holds and manages assets on behalf of another party, known as the beneficiary. Trusts can be used for a variety of purposes, including estate planning, asset protection, and tax planning. They are highly flexible and can be tailored to meet specific needs and goals.
Unit Trust Definition
A unit trust is a type of trust where the trust’s assets are divided into units, similar to shares in a company. Each unit represents a fraction of the trust’s assets, and investors (beneficiaries) can buy and sell units.
How Unit Trusts Work
- Trustee Role: The trustee manages the trust’s assets, which are typically pooled investments such as stocks, bonds, or real estate.
- Beneficiaries: The unit holders (investors) are the beneficiaries. They own units in the trust and are entitled to a share of the income generated by the trust’s assets, proportional to the number of units they own.
- Income Distribution: Income earned from the trust’s investments is distributed to unit holders based on their unit holdings. This distribution can occur regularly, such as quarterly or annually.
- Liquidity: Unit trusts offer liquidity, as units can often be bought and sold on the market, providing investors with the ability to enter or exit the investment relatively easily.
Example:
If a unit trust owns a diversified portfolio of stocks and bonds, and you own 100 out of 1,000 units, you effectively own 10% of the trust’s assets and will receive 10% of the income generated by those assets.
Discretionary Trusts Definition
A discretionary trust, also known as a family trust, is a trust where the trustee has the discretion to decide how the trust’s income and capital are distributed among the beneficiaries.
How Discretionary Trusts Work
- Trustee Role: The trustee has the authority to make decisions about the distribution of the trust’s income and assets. This means the trustee can choose which beneficiaries receive distributions, how much they receive, and when they receive it.
- Beneficiaries: Beneficiaries do not have a fixed entitlement to the trust’s assets or income. Instead, they have a potential interest, which depends on the trustee’s discretion.
- Flexibility: This type of trust provides flexibility, allowing the trustee to adapt to changing circumstances and needs of the beneficiaries, such as providing more support to a beneficiary in financial need.
- Asset Protection and Tax Planning: Discretionary trusts can be used to protect assets from creditors and to manage tax liabilities by distributing income in a tax-efficient manner among beneficiaries.
Example:
If a discretionary trust is set up to benefit the settlor’s children and grandchildren, the trustee may decide to distribute more income to a child who is paying for college tuition, while providing less to another child who is financially independent.
Key Features of Unit Trusts
A unit trust is a type of trust structure where the trust property is divided into units, similar to shares in a company. Each unit holder has a fixed entitlement to a proportion of the trust’s income and capital based on the number of units they hold.
The trust deed outlines the rights and obligations of the unit holders and the trustee. It’s like a rulebook for how the trust operates.
Key Features of Discretionary Trusts
Discretionary trusts or family trusts are a bit different. With these trusts, the trustee has discretion over how the income and capital are distributed to the trust beneficiaries.
The beneficiaries don’t have a fixed entitlement to the trust’s assets. Instead, the trustee decides how much, if any, each beneficiary receives. This flexibility can provide asset protection and tax planning opportunities.
Similarities Between Unit Trusts and Discretionary Trusts
While unit trusts and discretionary trusts have their differences, they also share some key similarities. In both cases, a trustee holds and manages assets for the benefit of the beneficiaries.
The trust deed is the legal document that establishes the trust and sets out the rules for how it operates. And both types of trusts can be used for various purposes, like investment, asset protection, and estate planning.
Differences Between Unit Trusts and Discretionary Trusts
Ownership and Control
In a unit trust, the unit holders have a fixed beneficial ownership in the trust’s assets, similar to shareholders in a company. The trustee must act according to the unit holders’ directions.
But with discretionary trusts, the beneficiaries have no ownership rights. The trustee has complete control over how the income and capital are distributed.
Distribution of Income and Capital
Unit trusts allocate shares of income and capital to unit holders based on their fixed proportional entitlement. So if you own 25% of the units, you’re entitled to 25% of the distributions.
Discretionary trusts are different. The trustee gets to decide how to distribute the income and capital among the beneficiaries. This flexibility can be useful for tax planning and asset protection.
Flexibility and Asset Protection
When it comes to flexibility and asset protection, discretionary trusts have the upper hand. The trustee’s discretion over distributions can help protect assets from creditors and legal claims against beneficiaries.
Unit trusts provide less flexibility and asset protection since unit holders have a fixed entitlement to the trust’s assets. It’s harder to move things around when everyone’s ownership is set in stone.
Tax Implications of Unit Trusts vs Discretionary Trusts
Taxes are a big consideration when choosing between a unit trust and a discretionary trust. Let’s take a look at some of the key tax implications.
Income Tax Treatment
Unit trusts are taxed similarly to companies, with the trustee paying tax on behalf of the trust at the corporate tax rate. Unit holders then receive distributions of after-tax income.
Discretionary trusts, on the other hand, are generally taxed at the individual marginal tax rates of the beneficiaries who receive the distributions. This can potentially offer tax advantages if distributions are made to beneficiaries in lower tax brackets.
Capital Gains Tax
When it comes to capital gains tax, unit trusts and discretionary trusts are treated differently. In unit trusts, capital gains are taxed at the trust level, with unit holders receiving a credit for the tax paid.
But in discretionary trusts, capital gains can be distributed to beneficiaries in lower tax brackets. This can potentially reduce the overall tax liability compared to a unit trust.
Land Tax and Stamp Duty
Both unit trusts and discretionary trusts may be subject to land tax and stamp duty on the transfer of dutiable property, like real estate. But some states offer exemptions or concessions for certain types of trusts.
For example, trusts used for primary production or charitable purposes may get a break on these taxes. It’s important to check the specific rules in your state to see if your trust qualifies for any special treatment.
Key takeaway: Unit trusts give fixed entitlements, like shares in a company. Discretionary trusts let trustees decide distributions, offering flexibility and asset protection.
When to Use a Unit Trust or Discretionary Trust
Choosing between a unit trust and a discretionary trust depends on your specific needs and goals. Let’s explore some common scenarios where each type of trust might be most suitable.
Investment Purposes
Unit trusts are often used for pooled investment schemes, such as property trusts or managed funds. They allow investors to acquire a proportional interest in a diversified portfolio of assets. Each unit holder has a fixed entitlement to the trust’s income and capital, making it easier to manage and predict returns.
On the other hand, discretionary trusts are less commonly used for public investment purposes due to their lack of fixed entitlements. The trustee’s discretion over distributions can make it challenging to attract investors who prefer certainty and transparency.
Estate Planning and Asset Protection
Discretionary trusts are popular for estate planning and asset protection. They can help protect assets from creditors and legal claims, as beneficiaries do not have a fixed entitlement to the trust’s assets. This is particularly useful in high-risk professions or for individuals with significant wealth.
The trustee’s discretion over distributions can also facilitate tax-effective intergenerational wealth transfer. By distributing income and capital to beneficiaries in lower tax brackets, such as adult children, the overall tax liability can be reduced. However, it’s essential to seek professional advice to ensure compliance with tax laws and avoid potential pitfalls.
Business Structures
Unit trusts are sometimes used in business structures, particularly for joint ventures or small-scale enterprises. They allow multiple parties to own and control the business assets in fixed proportions, similar to a partnership or company structure. Unit trusts can be especially useful when involving self-managed superannuation funds (SMSFs) in the ownership structure.
Discretionary trusts are less suitable for commercial dealings due to the lack of certainty over ownership and control. However, they can still be used in certain circumstances, such as holding intellectual property or real estate assets separate from the main trading entity for asset protection purposes.
Setting Up and Managing Unit Trusts and Discretionary Trusts
Once you’ve decided on the appropriate trust structure for your needs, it’s crucial to set up and manage the trust correctly. This involves appointing a suitable trustee, drafting a comprehensive trust deed, and ensuring ongoing compliance with legal and tax obligations.
Appointing a Trustee
Choosing the right trustee is a critical decision for both unit trusts and discretionary trusts. The trustee can be an individual or a corporate entity, such as a professional trustee company. They must be capable of fulfilling their duties and obligations under the trust deed and relevant laws.
When appointing an individual trustee, consider their expertise, reliability, and potential conflicts of interest. Corporate trustees offer greater asset protection and continuity but come with additional costs and compliance requirements.
Drafting the Trust Deed
The trust deed is the legal document that establishes the trust and sets out its rules. It should be carefully drafted by a qualified legal professional to ensure it meets the specific needs and objectives of the trust. The deed should cover aspects such as the trust’s purpose, beneficiaries, trustee powers, and distribution rules.
For unit trusts, the deed should clearly define the rights and entitlements of unit holders, including their proportional interest in income and capital. For discretionary trusts, the deed should provide guidance on how the trustee exercises their discretion over distributions while maintaining flexibility.
Compliance and Reporting Obligations
Trustees of unit trusts and discretionary trusts must comply with various legal and tax obligations. These may include lodging annual tax returns, maintaining proper records, and reporting to beneficiaries. Failure to meet these obligations can result in penalties and legal consequences.
Trustees can seek professional advice from expert accountants at BOA & Co. Financial Group to ensure they understand and meet their compliance requirements. This will help you in keeping accurate financial records and staying up-to-date with changes in tax laws and regulations.
Key takeaway: Choose a unit trust for predictable investment returns and ease of management. Opt for a discretionary trust to protect assets, manage tax effectively, or facilitate estate planning.
Conclusion
Now, we’ve covered the topic ‘unit trust vs discretionary trust’ in detail. We know now that each has its own strengths and weaknesses. It all comes down to your specific needs and goals.
If you’re looking for a more structured, transparent arrangement with fixed entitlements, a unit trust might be the way to go. But if flexibility and asset protection are your top priorities, a discretionary trust could be the better fit.
Ultimately, the choice between a unit trust and a discretionary trust depends on your unique situation. Need professional assistance? Our friendly experts at BOA & Co. Financial Group can help you make an informed decision that sets you up for long-term success.
For personalized advice on trust structures and to find the best solution for your needs, contact us at 1300 952 286 or info@boanco.com.au