What is the Difference Between Fixed and Discretionary Trusts?

Summary

• A trust splits ownership of property into two parts — the legal title, held by the trustee, and the beneficial interest, held by the beneficiary — allowing property to be managed and distributed in a controlled and tax-efficient manner.
• In a fixed trust, the beneficiaries and their entitlements are clearly defined by the settlor from the outset, whereas in a discretionary trust, the trustee has discretion to decide which objects benefit from the trust property and in what amounts.
• Trusts can be used for a range of purposes, including nominating a professional to manage assets, distributing property to specific people at a specific time, and passing on property upon death in a tax-efficient way.
• This article explains the difference between fixed and discretionary trusts for individuals and business owners in England.
• LegalVision, a commercial law firm specialising in advising clients on trusts and property law, outlines how trusts operate and when each type may be appropriate.

Tips for Businesses

When creating a trust, clearly define the beneficiaries and their entitlements in the trust instrument to avoid disputes. If flexibility in distribution is needed, consider a discretionary trust, but ensure the trustee understands their obligations. Take specialist advice where trusts are used for tax planning or estate purposes, as the structure must be carefully documented.

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On this page

• How Trusts Operate
• Creating Trusts
• Fixed vs Discretionary Trusts
• Key Takeaways 
• Frequently Asked Questions 

A trust splits ownership of property into legal title and beneficial interest, allowing one person to hold property on behalf of another. The key distinction between fixed and discretionary trusts lies in how much control the trustee has over distributing that property. This article explains the differences between fixed and discretionary trusts in England.

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How Trusts Operate

Trusts refer to a unique way of holding property. Property refers to anything capable of value, including:

• shares in a company; 
• land; 
• money; and
• bank accounts and loans.

Trusts take the legal principle of ownership in a piece of property and split it up into two separate parts:

• the beneficial interest; and 
• the legal title.

When split, the law says the property is held “on trust”, meaning that the trustee holds property on trust on behalf of the beneficiary.

Trusts often contain at least three people:

• the settlor (who creates the trust and transfers the property to the trustee); 
• the trustee (who holds the trust property); and 
• the beneficiary (who will ultimately benefit from the property of the trust when certain conditions are met). 

Ownership in Shares 

Suppose you own a single share in a company. In this context, ownership refers to:

• the right to benefit from the property; and 
• the right to sell, loan, gift, or use the property as collateral for a loan.

How do you benefit from a share? Depending on the kind of share you own, you might be able to:

• receive a dividend payment; 
• attend and vote in the shareholder meetings; and
• receive a portion of the company’s equity if it is wound up.

In other words, you have the beneficial interest in the share if you can enjoy its value. 

This is different from having the legal title, which gives you the right to dispose of the property as you wish. For instance, you can choose to sell the share to a friend and receive money. However, if you do not have the legal title to the share, you do not have the right to do this.

Creating Trusts

As the beneficial owner of property, you enjoy both the beneficial interest and legal title. Likewise, you have the right to split these rights into two and transfer them to other persons. A trust automatically arises when you split the beneficial interest and legal title. 

There are several reasons you might create a trust. We will consider three.

1. Nominating a Professional

In some circumstances, you might want to nominate a professional to act on your behalf. As such, you can transfer the legal title in your share portfolio to a financial adviser. In doing so, you give them the legal right to manage your portfolio by trading the shares to grow the portfolio. 

Likewise, you maintain the right to vary the terms of the trust or bring it to an end at any time. This is known as a “bare trust”.  

2. Distributing Assets

Another advantage to creating a trust is that it allows you to distribute assets to specific people, in a certain way, at a certain time. 

For example, you may have a lot of shares in a company and wish to pass these benefits on to your grandchildren. However, you predict that the company will continue to grow. As such, it is not ideal to sell your company shares outright and give your grandchildren the proceeds of the sale. Therefore, you can declare a trust on their behalf and keep the legal title under your name but transfer the beneficial interest to them. This entitles them to receive the dividend payments, but they have no right to sell the shares. They would also benefit from you voting on their behalf at shareholder meetings. 

3. Passing on Property Upon Death

A trust is also an effective way to pass on your property to others after you die in a tax-efficient manner. You can structure trusts in such a way that the beneficiaries are not required to pay estate tax on the property they receive after you die.

For example, suppose you want some of your grandkids to benefit from your property but are unsure which ones. In your will, you can specify that some of your property will be held on trust for all of your grandchildren. Likewise, you can detail that the trustee will manage the property to determine which grandchild should benefit from the trust and how much money they should receive. 

In all three examples, a trust is created once ownership in the property is split so that the legal title and beneficial interest do not exist in a single person. 

Fixed vs Discretionary Trusts

A fixed trust refers to a trust that clearly defines:

• who the beneficiaries are;

Examples (1) and (2) are fixed trusts because it is very clear who the beneficiaries are and what they are entitled to in both cases. 

In example (3), this is not so clear. You intend to create a trust for the benefit of a class of people (your grandchildren). Yet, it is unclear who the beneficiaries are or how much they stand to receive. Instead, you leave it to your trustee to make this decision. This is a discretionary trust. Importantly, your grandchildren are not beneficiaries until the trustee exercises their discretion on their behalf. Until then, they do not actually have a beneficial interest in the property. Instead, they are known as “objects” to the trust. 

There are different obligations and powers placed upon a discretionary trustee compared to a trustee of fixed trusts, but this is beyond the scope of this article.

Key Takeaways 

All trusts take the legal concept of ownership and split it into the legal title to the property and the beneficial interest in it. Notably, there are two types of trusts: fixed and discretionary trusts. A discretionary trust gives the trustee ultimate discretion over how to distribute the trust property to the beneficiaries. In a fixed trust, this is specified by the settlor in the trust instrument. 

If you need help navigating trusts in a commercial context, LegalVision provides ongoing legal support for businesses through our fixed-fee legal membership. Our experienced business lawyers help businesses manage contracts, employment law, disputes, intellectual property, and more, with unlimited access to specialist lawyers for a fixed monthly fee. To learn more about LegalVision’s legal membership, call 0808 196 8584 or visit our membership page.

Frequently Asked Questions