What is a discretionary trust?

A discretionary trust allows a trustee discretion to make decisions about distribution, with some limitations specified in the trust document. A discretionary trust is typically used for the purpose of avoiding creditors, exercising control over a minor beneficiary, and caring for an incapacitated surviving spouse.

How a Discretionary Trust Can Block Creditors

There is nothing worse than realizing that your estate may be placed into the hands of your irresponsible child’s creditors. We’ve all seen the commercials for businesses that will allow beneficiaries to sign over a lump sum of their trust funds for a much smaller upfront payment. It’s concerns over these precarious transactions that have prompted the use of discretionary trusts to block beneficiary creditors.

In order to limit creditors, a spendthrift provision, called “Restriction Against Assignment,” is placed in the discretionary trust document. An example of the phrasing for this provision would be: “No interest in the principle or income of this trust shall be anticipated, assigned, encumbered, or subjected to any creditor’s claim or to legal process before its actual receipt by the beneficiary.” While this provision does limit a creditor’s ability to take money directly from the discretionary trust, it does not prevent the creditor from garnishing an irresponsible child’s payment.

Discretionary Trusts and a Minor Beneficiary

Estate planning is one area that many parents do not feel comfortable thinking about. However, properly providing for your minor children in the event of your death is a very important step that should be considered by every parent. One of the ways to ensure your minor child’s needs are met is to create a discretionary minor trust. This form of trust allows the trustee discretion within specified boundaries to provide for your minor children and even slowly distribute the trust funds to the children once they are adults.

Discretionary minor trusts are set up through your will, as they are meant as a precaution, not an actual established trust. The phrasing for a discretionary minor trust should include: “So long as the trustor’s children are living who are under twenty-one, the trustee shall pay to or apply for the benefit of all the trustor’s children as much of the net income and principal as the trustee in the trustee’s discretion deems necessary for their proper support, health, and education, after taking into consideration, to the extent that the trustee considers advisable, the value of the trust assets, the relative needs, both present and future, of each of the beneficiaries and their other income and resources made known to the trustee and reasonably available to meet beneficiary needs. The trustee may make distributions under this provision that benefit one or more beneficiaries to the exclusion of others. Any net income not distributed shall be accumulated and added to principle.”

Special Needs Trusts and Providing for a Disabled Spouse

Similar to a discretionary minor trust, a discretionary trust can be created to ensure that a disabled spouse’s needs are met. In fact, discretionary disabled spousal trusts, also referred to as special needs trusts, can even go a step further and only release payment for expenses not covered by insurance, Social Security, or Medicare.

These special needs trusts are set up before the first spouse dies and typically go into effect at the death of the first spouse. A discretionary disabled spouse trust must include the following provisions to ensure proper release of payment: “So long as the trustor’s spouse is disabled, the trustee shall pay to or apply for the health, safety, and welfare of the beneficiary in ways not provided for by any public agency, that no part of the corpus may be used to replace public benefits.”

Case Studies: Illustrating the Applications of Discretionary Trusts

Case Study 1: Protecting Trust Assets From Creditors

John and Sarah have substantial wealth and are concerned about protecting their assets from potential creditors. They establish a discretionary trust, including a spendthrift provision that prevents creditors from accessing the trust funds directly. This provision safeguards the trust assets and ensures their preservation for the beneficiaries while offering some peace of mind to John and Sarah.

Case Study 2: Providing for Minor Children’s Future

As loving parents, David and Lisa want to ensure that their minor children’s needs are met even in their absence. They create a discretionary minor trust within their wills.

This trust grants the trustee the flexibility to allocate the trust funds based on the children’s evolving needs, such as support, health, and education. By utilizing a discretionary trust, David and Lisa can rest assured that their children will receive appropriate care and financial support.

Case Study 3: Ensuring Financial Security for a Disabled Spouse

Mark is disabled and requires ongoing financial assistance. To secure Mark’s future, Mark and Emily establish a discretionary disabled spouse trust, commonly known as a special needs trust.

This trust ensures that Mark’s needs, which are not covered by public benefits, are adequately addressed. The trustee has discretion to utilize the trust funds for Mark’s health, safety, and welfare, providing an added layer of financial security for Mark.

Getting Legal Help

If a discretionary trust seems like a good option for your estate planning needs, contact an estate planning attorney to set up a consultation.