Discretionary Trusts And Estateably

Discretionary Trusts And Estateably

The Estateably Team
October 12, 2023


A discretionary trust gives the trustees the power to decide how income, capital, or both should be distributed to a class of beneficiaries. The trustees typically have a duty to pay the beneficiaries but may exercise discretion in determining which beneficiaries will receive income and capital and how much each beneficiary will receive. Sometimes, a settlor will choose a discretionary trust in a deliberate decision not to give property or its resulting income to a beneficiary. The trustee has the power of choosing if and when a beneficiary receives the trust funds, and the beneficiary does not always have an enforceable right to the property. In many cases, the settlor will choose to include a letter of wishes to help their chosen trustees navigate the trust's administration per their intentions. Discretionary trusts may be either testamentary or inter vivos, allowing for greater diversity in their application.

Exercise of Discretion 

Most discretionary trusts set limitations to this discretion, often by limiting the choice of beneficiaries to a particular class and prescribing conditions to consider when the trustee(s) weighs payment. For example, a settlor may name a widow as the trustee and the settlor's children as the beneficiaries. The trust instrument may include language guiding the trustee on when to pay the beneficiaries, such as allowing the widow to decide when it is necessary to pay the income or capital for the maintenance, care, education, or benefit of the beneficiaries. A fixed trust would require the widow to pay the settlor's children in the amounts stated in the governing instrument. However, the discretionary trust allows the trustee to make the decisions freely and on their own. When one child has issues paying rent, the trustee may decide to pay them to secure their housing. Later, the trustee may provide or withhold payment when the other child asks for money to take night classes, for instance.

Although bound by the criteria set out in the instrument, the discretionary trust allows greater flexibility for a settlor to give their trustees broad powers in distributing the trust property. The trustee(s) will have the ability to either pay income to the different beneficiaries or choose to accumulate it for later purposes. Furthermore, the flexibility of discretionary trusts allows for greater control over the distributions' impact on taxes and other obligations. This trust can better protect beneficiaries from creditor claims, provides for adaptive income splitting between beneficiaries, and can defer capital distributions until a beneficiary is older and able to manage their finances independently. Discretionary trusts are very popular for tax purposes, as a financially savvy trustee can best allocate resources to minimize the trust's taxable funds through income splitting and other strategies for distribution. As more settlors shift to these strategies, documenting a trust's transactions and transfers has never been more important.

Court Authority

The discretionary trust decreases a court's ability to interfere with the management of the trust. When a trustee has the authority to exercise their discretion in providing for the beneficiaries, the Court can not substitute their own discretion. Numerous courts, such as the Saskatchewan and Ontario Courts of Appeal in Sayers et al. and Philip, Re, 1973 38 DLR (3d) 602 and Edell v. Sitzer, 2004 9 ETR (3d) 1, restated that the court will only interfere if the trustee refuses to exercise any real discretion or exercises choice in a prejudicial manner (to the beneficiaries' interests). Trustees must exercise their power correctly pursuant to the trust instrument. With these more relaxed conditions, those managing discretionary trusts must be clear in their asset management, documentation, and exercise of powers. A good trustee will utilize all the tools available to make the trust an open book and keep beneficiaries informed. Doing so will demonstrate their good faith to the courts if any future issues surface. Thankfully, innovative legal technology is available to help record the exercise of this discretion and it's financial impact on the trust funds, offering better protection in the event of a court challenge.

Absolute Trusts and Henson Trusts

At the extreme end, absolute discretionary trusts, also known as Henson trusts, give the trustees complete discretion in paying the beneficiary so they may still qualify for support programs or benefits. Persons living with disabilities and relying on government support are most susceptible to changes in regulations, legislation, personal health, and other factors. The absolute discretionary trust's flexibility allows trustees to ensure the beneficiary's access to services while remaining adaptive to any change in circumstances. 

The purpose of the absolute discretionary trust was established in the seminal Ontario v. Henson (1987), 26 O.A.C. 332. This case demonstrated the viability and the name of a “Henson Trust”, which gives absolute discretion to the trustee(s) in distributing assets. Henson was a single disabled person who lived off of a government allowance. However, the Family Benefits Act (the Act) rescinded the assistance if the dependent person held liquid assets above $3 000. Henson was a beneficiary of a trust of $82, 000, but the funds remained under the complete discretion of the trustees. The testator also ensured the trust would not vest in Henson; any residue of the estate would transfer to a Guelph District Association charity for disabled persons. 

The Ontario Divisional Court had to determine whether the social assistance office could use the trust assets to determine Henson's qualification for the allowance. A beneficial interest held in trust would generally qualify as a liquid asset for the Act. The Court reasoned that the trustees had “absolute and unfettered” discretion. Henson could not compel the trustees to make payments. In this case, the beneficiary did not have a beneficial interest in the trust. 

Supreme Court Affirmation

The recent S.A. v. Metro Vancouver Housing Corp., 2019 SCC 4 allowed the Supreme Court to reaffirm the holding of Ontario v. Henson and increase its viability outside of Ontario. The appellant was a person with disabilities who resided in a rental assistance home run by the MVHC. The MVHC required proof of low income to qualify for the reduced rental rate. Since the appellant was a co-trustee and the sole beneficiary of a discretionary trust, the MVHC attempted to include the trust's assets within her income calculation. In the appellant's opinion, the absolute trust prevented her from collapsing it or compelling any payments to herself as beneficiary. The lower courts all determined that the Appellant's interest in the trust was an asset that the MVHC could consider in its calculation. With her rental assisted housing jeopardized, the appellant appealed. 

The Supreme Court quashed the lower courts' opinions. By its nature, the discretionary trust did not require the trustees to distribute the trust assets to the appellant. The appellant had no control over whether she would get money from the trust and could not rely on it to pay rent. As a co-trustee, she could not draw on the funds on her own but needed the approval of the other co-trustee. Furthermore, as the appellant argued in her factum, the Henson trust prevented the beneficiary from collapsing the trust under the Saunders v. Vautier rule, and the remainder of the trust's capital would gift-over to another entity. These two factors became the centerpoint of the Supreme Court's framing of the issue. Since the trust could not be dissolved for the appellant's benefit and any distribution relied on a unanimous decision between the two trustees, the Henson trust's assets could not be considered the beneficiary's own. She only held the “mere hope” that the property would be distributed to her. With this decision, the Supreme Court reaffirmed that beneficiaries do not have any beneficiary interest in absolute discretionary trusts. If properly drafted and followed by the trustee(s), a Henson trust can help persons in need retain their assistance payments and other government benefits. Following these complex rules can be incredibly difficult without the right software guiding the trustee's actions.

Estateably's Edge

Estateably empowers trustees and their lawyers to be confident in managing any discretionary or Henson trust. Documenting decisions, distributions, and transfers is essential to the proper functioning of these flexible trusts. Our software allows users to record a trust instrument's instructions and refer to them when making relevant decisions. It also allows them to document notes throughout the lifetime of the trust for safekeeping. Users can catalog beneficiary requests for payment and describe subsequent exercise of discretion. Our software will soon allow beneficiaries to directly request payment through our platform. These requests can be granted or denied by the trustee, allowing for the easy management of the trust's affairs all in a single app. Estateably helps increase the transparency in administering discretionary trusts and fosters a better relationship between beneficiaries, their trustees, and their lawyers.

Professionals can remain confident when managing distributions. Our inventory system maintains an organized list of the trust's capital and income assets. The interactive and intuitive system ensures the trustee has all the knowledge they need to make an informed decision. When paying the beneficiaries, the trustee can track the distributions in a simple and easy-to-read menu. This management system will help them stay true to the settlor's original intent.

When necessary, the trustee or their lawyer generate accounting and distribution reports with the click of a button. These reports can shed light on the trustees past actions and help guide their future decisions. It has never been easier to track the exercise of discretion and its impact on payments. 

Learn more about Estateably's trust administration software and how it can optimize the management of your discretionary trusts.

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