Misconception and facts about a Settlor’s role in a Discretionary Trust

News | Anjali Aggarwal | Released: 27/11/2024 | Read: 5 Mins

Understanding the Settlor's fundamental role

The settlor is the individual or entity responsible for creating a trust by transferring an initial asset (often a nominal sum, such as $10) into the trust. This initial transfer sets up the trust, giving legal effect to the relationship between the trustee, beneficiaries, and the trust's assets.

 

The settlor plays a vital role in the establishment of a trust. The key responsibilities associated with this role includes:

• Creation of the Trust: The settlor establishes the trust by transferring an asset—such as cash, property, or investments—into it. This process formalizes the trust and sets it into motion.

• No Ongoing Control: Once the trust is created, the settlor typically has no further involvement in the trust’s administration or decision-making. Responsibility for managing the trust and distributing its assets falls entirely to the trustee, who must act in accordance with the trust’s terms.

 In short, the settlor's role is to lay the groundwork for the trust, ensuring it is set up correctly to achieve its intended purpose.

Who is eligible to act as a settlor is just as important as understanding their responsibilities?

While the role of the settlor is crucial, not all individuals or entities are eligible or suitable to assume this responsibility. Several legal and practical considerations must be taken into account when selecting a settlor.

 

1. Legal Capacity: The settlor must possess full legal capacity, which typically requires being an adult (18 years or older) of sound mind and free from legal disabilities or restrictions, such as bankruptcy or guardianship.

 

2. Compliance with Legal and Tax Frameworks: The settlor’s actions must align with the relevant legal and tax frameworks to avoid inadvertently invalidating the trust or exposing it to legal challenges.

 

The eligibility and appropriateness of specific individuals or entities acting as settlors depend on the structure and objectives of the trust. Below is an analysis of who can, and should, assume this role.

 

 

Who Should - and - Should Not Act as a Settlor?

2. Should a Family Member Be a Settlor?

 

Appointing a family member as the settlor is another option that is legally permissible but often not recommended. A family member acting as settlor may create conflicts of interest, especially if they are also a beneficiary. This overlap can complicate the administration of the trust and invite scrutiny from legal or tax authorities.

 

3. Is an Independent Third Party a Suitable Settlor?

When establishing a discretionary trust, appointing the most suitable settlor is critical. In most cases, an independent third party or corporate entity is the preferred choice to ensure legal and administrative clarity.

Some of the common misconceptions

Misunderstandings about the settlor’s role can lead to poor decision-making when setting up a trust. Here are a few common misconceptions:

 

Misconception #1: The Settlor Retains Control Over the Trust

Many believe that the settlor continues to manage the trust after its creation. In reality, the settlor’s role typically ends once the trust is created, and all decisions are made by the trustee.

 

Misconception #2: A Family Member Is the Best Choice for Settlor

While legally permissible, appointing a family member can create conflicts of interest and tax complications, especially if they are also a beneficiary.

 

Misconception #3: An Independent Settlor Is Too Expensive

Appointing a third party may involve fees, but these are often outweighed by the long-term benefits of avoiding legal and tax issues.

 

Misconception #4: The Settlor Is Liable for the Trustee’s Actions

The trustee, not the settlor, is responsible for managing the trust in accordance with the trust deed. The settlor is not liable for the trustee’s decisions.

Conclusion

Choosing the right settlor for a family trust is a critical decision that involves careful consideration of legal, tax, and practical factors. To maintain the integrity of the trust, minimize conflicts of interest, and optimize asset protection, appointing an independent third party as the settlor is highly recommended. This approach helps ensure the trust is managed impartially and efficiently.

 

In line with this principle, our trust deed explicitly prohibits the settlor from having any ongoing role in the administration or benefits of the trust. It also ensures the settlor cannot be appointed as an appointor or a beneficiary, thereby avoiding potential conflicts and maintaining clear, distinct roles within the trust structure. This safeguard is key to protecting the trust’s long-term success.

Visit www.trustdeed.com.au for more details or call us on (02) 9684 4199

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