Protective and Discretionary Trust

Protective Trust and their Purpose

The purpose of a protective trust is to make provisions for a principal beneficiary(PB), but to protect the trust from dissipation if the PB is irresponsible/unlucky and threatens to run up debts or disposes of the trust property to another person and away from his family. The most common determining event is bankruptcy.

The trust will end if a certain event happens, such as bankruptcy or a purported dealing, so that the income becomes payable to another person.  A discretionary trust will then arise in which the principal beneficiary will be a potential beneficiary, along with his spouse and family members.  Creditors will have no right to the income from the trust and therefore this is one way in which the income can be protected for the benefit of the principal beneficiary and his family. 

Important Features

  • It is designed to protect the beneficiary from the consequences of getting into debt.
  • The purpose of the protective trust is to protect the debtor and his family (beneficiary and his family) from their creditors.
  • These may be expressly drafted or determined in accordance with section 33 Trustee Act 1925.
  • Normally a beneficiary holds a life interest which ends as soon as the beneficiary does something which may put him into debt.
  • The trust property is held on a discretionary trust for the benefit of the principal beneficiary, his/her spouse and children.
  • The property belongs to trust and the beneficiary has no legal or equitable interest so creditors cannot proceed against the trust property.
  • To create a protective trust, the settlor just need to use the word “Protective Trust” in the Trust Instrument

Example

I leave my house under protective trust for the benefit of my sister.

  • When writing a will apart from the use of word Protective Trust it is advisable that the life interest must be made determinable (to be put to an end) and words such as while, until, during and as long as should be used

Example

If John Simpson should in any manner sell, assign, transfer, dispose of or anticipate his share or any part thereof then immediately after such event the bequest in trust for John Simpson should cease, determine(end) and become void.

Determining Event

The life interest in a protective trust determines (ends) when the life tenant (beneficiary) gets into debts or does something which he is prohibited from doing so under the trust. The determining event will make the protective trust as a discretionary trust.

Discretionary Trusts

Discretionary trusts are used

  • To protect beneficiaries against creditors: the trustee in bankruptcy is not entitled to claim any part of the fund upon bankruptcy of a discretionary beneficiary, only goods or money in the form of cash is paid over by the trustees to the beneficiary in the exercise of their discretion.
  • To exercise control over young or weak beneficiaries.
  • To react to changes in beneficiary’s circumstances.
  • To avoid tax, as the beneficiary’s interest is intangible.

 It is therefore difficult for the tax authorities to devise suitable basis of taxation for what can be major sources of wealth. Changes introduced by the Finance Act 2006 means that they are now taxed in a similar manner to most other trusts.

Form of Discretionary Trust

Trustees will hold property on a trust and are under a duty to apply the income or capital or both for the benefit of the members of a class of beneficiary in such proportions as the Trustees shall, in their absolute discretion, think fit.  No individual beneficiary is entitled to a share of the property, whether income or capital.  Therefore, a beneficiary does not have any interest in the property.  If he dies, no inheritance tax is payable.  However, he can compel trustees to exercise their discretion.

The trust period:  The trust period must be less than the perpetuity period which is the life of a beneficiary plus 21years of a beneficiary at most, specific time period can also be specified by the settlor/testator.  The property must vest within this period (i.e. property will only vest when the trustees exercise their discretion in the favour of an individual beneficiary.)  At the end of the discretionary trust, there is usually a “gift over” on fixed trusts which must vest within the perpetuity period.

Disclaimer

While every effort has been made to ensure the accuracy of the information provided in this article, it does not constitute legal advice and cannot be relied upon as such. Each legal case and issue may have unique facts and circumstances, as a result legalally does not accept any responsibility for liabilities arising as a result of reliance upon the information provided. For further help and guidance, you can always rely on and seek advice from our experienced lawyers.

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