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Trust Law/Level III · Family trusts/3.2 Trusts made by will/Lesson 4

Discretionary trusts: trustee judgement as the rule

How a trust can let the trustee decide who receives what, and when

Education, not legal advice. Trust law changes from country to country and state to state, and the right structure depends on your situation. Anything you sign should be drafted or reviewed by a qualified lawyer where you live.

The lean path

The cheapest, lowest-tax, simplest and most private route the law allows, best first. Each step names the rule it rests on and the condition that keeps it lawful.

  1. Discretionary terms give creditor protection at no extra cost: under UTC §504 a beneficiary’s creditor cannot compel a discretionary distribution, even without a spendthrift clause. Catch: the model text lets child-support claimants reach abused discretion, and states differ.
  2. Distribute income to beneficiaries in lower tax brackets: the trust deducts what it pays out (IRC §661), and payments in a year’s first 65 days can count for the prior year (§663(b)). Catch: the fiduciary must elect that, and recipients report the income.
  3. Steer the trustee with a free letter of wishes rather than paying to redraft as needs change. Catch: it is not legally binding, so anything that must happen has to be in the trust itself.
  4. Where a family member is both trustee and beneficiary, limit their own distributions to health, education, maintenance and support (UTC §814; IRC §2041) to keep the trust out of their estate. Catch: wider distributions need an independent co-trustee.
  5. Keep short written notes of each distribution decision; they are the cheapest defence. Catch: beneficiaries can still ask a court to review bad-faith or arbitrary decisions (UTC §504).

MaterialsA copy of your current will or testamentary trust instrumentThe Uniform Trust Code §504 text for your state (if applicable)A sample letter of wishes, if your trust has or may have oneA list of potential beneficiaries and their specific needs

Wonder

  1. Can a beneficiary force the trustee to pay out money if they are in financial distress?
  2. What is the legal difference between ‘sole discretion’ and an ‘ascertainable standard’ like health or education?
  3. How can a settlor guide trustees without legally binding them?

Explore

  1. In a discretionary trust, the trustee decides whether, when and how much to pay to each beneficiary, within limits set by the trust document. No beneficiary has a fixed share or a right to a set payment. Discretion can be broad, such as ‘in the trustee’s sole and absolute discretion’, or tied to a standard, such as payments for health, education, maintenance and support. Discretionary trusts can be created by a will or as a living trust, and they are used in England, Canada, Australia and the US, under each country’s own rules.
  2. Broad wording does not make a trustee’s power unlimited. Under Uniform Trust Code §814, in states that adopted it, even when the trust uses words such as ‘absolute’, ‘sole’ or ‘uncontrolled’, the trustee must exercise discretion in good faith and in accordance with the terms and purposes of the trust. The same section says a power is still discretionary even if the document says the trustee ‘shall’ make distributions using that discretion. Courts generally give a trustee with broad discretion more room than one held to a standard.
  3. Settlors often leave a letter of wishes explaining how they hope the trustee will use the discretion, for example to favour education or to help a child who is struggling. A letter of wishes usually does not legally bind the trustee. The trustee may take it into account, but must still decide each request under the trust’s terms and purposes. If the settlor wants something to be required, it generally has to be written into the trust document itself, which then reduces the trustee’s flexibility.
  4. Under Uniform Trust Code §504, in states that adopted it, a creditor of a beneficiary generally cannot force the trustee to make a distribution that is subject to the trustee’s discretion. This applies whether or not the trust has a spendthrift clause, even if the discretion is expressed as a standard such as support, and even if the trustee has abused the discretion. The model version makes an exception for a child, spouse or former spouse with a support order, to the extent the trustee failed to follow a standard or abused its discretion. States vary; Maine, for example, left that exception out.
  5. A beneficiary keeps the right to go to court. Uniform Trust Code §504 says it does not limit a beneficiary’s right to bring a proceeding against a trustee who fails to exercise a discretionary power in line with the terms and purposes of the trust, or fails to follow a distribution standard. Courts look at whether the trustee acted in good faith, considered the purpose of the trust and did not act arbitrarily. They generally do not replace a reasonable decision with their own. Records of how decisions were made help show good faith.
  6. The wording shapes how a trust works. Broad discretion gives the trustee room to respond to changing needs and makes it harder for anyone to show a duty to pay a specific amount. A standard such as health, education, maintenance and support gives beneficiaries a clearer measure against which to hold the trustee. Where a trustee is also a beneficiary, Uniform Trust Code §814 limits distributions to themselves to an ascertainable standard. Each approach has trade-offs, and how they balance depends on the family, the beneficiaries and state law.

Key facts

  • In a discretionary trust, the trustee decides whether, when and how much each beneficiary receives, within the trust’s terms.
  • A letter of wishes usually guides but does not legally bind the trustee.
  • Under Uniform Trust Code §814, even ‘sole’ or ‘absolute’ discretion must be exercised in good faith and in line with the trust’s terms and purposes.
  • Under Uniform Trust Code §504, a beneficiary’s creditor generally cannot compel a discretionary distribution, even if the discretion is expressed as a standard; the model version has a support-order exception that some states, such as Maine, omit.
  • A beneficiary can ask a court to review a trustee who fails to exercise discretion in good faith or in line with the trust’s terms and purposes.
  • Courts usually give broad discretion more room than a standard, but do not allow bad-faith or arbitrary decisions.

Exercise nine, six, three, one

9CollectList up to 9 situations in which families sometimes consider a discretionary trust (many have fewer), such as a child with an addiction, a beneficiary facing debts or divorce, a relative needing care, or grandchildren not yet born, and note the main need or risk in each.
6ClusterSort these 9 scenarios into 6 categories based on whether they require strict asset protection, flexible support, specific educational funding, disability accommodations, generational wealth management, or crisis intervention.
3DistillReduce the 6 categories to 3 groups: protection, flexibility, and guidance on family values.
1CrystallizeWrite 1 sentence explaining, in your own words, how broad discretion and an ascertainable standard each affect how far a beneficiary can rely on the trust.

Fact check

Dates, figures and claims checked against the published sources listed below.

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