Beneficial entitlement - Fixed, discretionary, vested, and contingent interests

Learning Outcomes

After studying this article, you will be able to distinguish between fixed and discretionary interests in trusts, explain the difference between vested and contingent interests, and apply these concepts to practical trust scenarios. You will also understand how these interests affect beneficiaries’ rights and trustees’ duties, and identify the exam-relevant legal rules for each type of entitlement.

SQE1 Syllabus

For SQE1, you are required to understand the types of beneficial interests that can arise under a trust and their practical implications. In your revision, focus on:

• The distinction between fixed and discretionary interests in trusts
• The difference between vested and contingent interests
• The effect of these interests on beneficiaries’ rights and trustees’ duties
• How to identify and apply the correct legal rules to trust scenarios involving these interests

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which of the following best describes a discretionary trust?
   1. Each beneficiary is entitled to a fixed share of the trust property
   2. Trustees must distribute all income equally
   3. Trustees have discretion over who benefits and in what amount
   4. The trust must terminate on a fixed date

2. True or false? A vested interest gives a beneficiary an immediate right to trust property, even if enjoyment is postponed.

3. In which situation does a contingent interest arise?
   1. The beneficiary is absolutely entitled
   2. The beneficiary must satisfy a condition before becoming entitled
   3. The beneficiary is a trustee
   4. The trust is charitable

4. Can a beneficiary with a vested interest transfer that interest to another person before receiving the trust property?

Introduction

Beneficial entitlement determines who benefits from a trust and on what terms. For SQE1, you must be able to identify and explain the main types of beneficial interests: fixed, discretionary, vested, and contingent. These interests affect the rights of beneficiaries, the powers and duties of trustees, and the administration of trusts. Understanding these distinctions is essential for answering exam questions and advising clients on trust matters.

Fixed and Discretionary Interests

A trust may confer either a fixed or a discretionary interest on its beneficiaries. The distinction is fundamental to the operation of the trust and the rights of those involved.

Key Term: fixed interest A fixed interest is where the trust instrument specifies exactly what each beneficiary is entitled to receive from the trust property.

Key Term: discretionary interest A discretionary interest is where the trustees have the power to decide which beneficiaries receive trust property, how much, and when.

Fixed Interests

In a fixed trust, the settlor determines in advance the share or entitlement of each beneficiary. The trustees have no discretion over the division of the trust property. For example, a trust "for A and B in equal shares" gives each beneficiary a fixed entitlement.

Fixed interests provide certainty for beneficiaries and simplify the trustees’ duties. However, they lack flexibility if beneficiaries’ circumstances change.

Discretionary Interests

In a discretionary trust, the trustees decide which beneficiaries (from a defined class) will benefit, in what amounts, and at what times. The settlor gives the trustees discretion to respond to changing needs or circumstances.

Discretionary interests allow flexibility and can protect vulnerable beneficiaries, but beneficiaries have no guaranteed right to any part of the trust property until the trustees exercise their discretion in their favour.

Worked Example 1.1

A trust states: "to my three children in equal shares." What type of interest do the children have?

Answer: Each child has a fixed interest. The trustees must divide the trust property equally, and each child is entitled to a specific share.

Worked Example 1.2

A trust states: "to my trustees to distribute income among my grandchildren as they think fit." What type of interest do the grandchildren have?

Answer: The grandchildren have discretionary interests. The trustees decide who receives income and how much, and no grandchild is entitled to a fixed share.

Vested and Contingent Interests

Beneficiaries’ interests may also be classified as vested or contingent, depending on whether there are conditions attached to their entitlement.

Key Term: vested interest A vested interest is an immediate right to trust property, even if enjoyment is postponed until a future date.

Key Term: contingent interest A contingent interest is a right to trust property that depends on the occurrence of a specified event or condition.

Vested Interests

A vested interest arises when a beneficiary is identified and does not need to satisfy any further condition to become entitled. The beneficiary may have to wait to receive the property (e.g., until reaching a certain age), but the right exists now. If the beneficiary dies before receiving the property, the interest passes to their estate.

Vested interests are generally transferable and provide certainty for beneficiaries.

Contingent Interests

A contingent interest arises when a beneficiary’s entitlement depends on meeting a condition (e.g., surviving another person, reaching a certain age, or marrying). If the condition is not met, the interest never vests.

Contingent interests are less secure and may be lost if the condition fails. They are not usually transferable before vesting.

Worked Example 1.3

A trust states: "to my son if he reaches age 25." The son is currently 20. What type of interest does he have?

Answer: The son has a contingent interest. He will only become entitled if he reaches age 25.

Worked Example 1.4

A trust states: "to my daughter for life, then to my grandson absolutely." The grandson is 12. What type of interest does the grandson have?

Answer: The grandson has a vested interest in remainder. He is identified and does not need to satisfy any further condition, but his enjoyment is postponed until the daughter’s death.

The Rule Against Perpetuities

All contingent interests must vest, if at all, within the perpetuity period (currently 125 years for most new trusts). This rule ensures that property is not tied up indefinitely.

Key Term: rule against perpetuities The legal rule that prevents interests in property from vesting too far in the future, requiring that they must vest within a set period (usually 125 years).

Beneficiaries’ Rights and Trustees’ Duties

The type of beneficial interest affects both the rights of beneficiaries and the duties of trustees.

• Beneficiaries with fixed or vested interests can generally enforce their rights and may transfer their interests.
• Beneficiaries with discretionary or contingent interests have no enforceable right until the trustees exercise their discretion or the condition is satisfied.

Trustees must act in accordance with the trust instrument and the type of interest conferred. In discretionary trusts, trustees must consider all potential beneficiaries and exercise their powers in good faith.

Key Term: beneficiary principle The principle that a private trust must have identifiable beneficiaries who can enforce the trust.

Key Term: certainty of objects The requirement that the class of beneficiaries is defined with sufficient clarity so that the trustees and the court can determine who is entitled.

Exam Warning

In discretionary trusts, beneficiaries cannot compel trustees to distribute property in their favour. They only have the right to be considered. Do not confuse this with fixed trusts, where beneficiaries can enforce their entitlement.

Revision Tip

For SQE1, always check whether a beneficiary’s interest is vested or contingent, and whether the trust is fixed or discretionary. This will determine their rights and the trustees’ obligations.

Summary

Key Point Checklist

This article has covered the following key knowledge points:

• The distinction between fixed and discretionary interests in trusts
• The difference between vested and contingent interests
• How the type of interest affects beneficiaries’ rights and trustees’ duties
• The application of the rule against perpetuities to contingent interests
• The importance of the beneficiary principle and certainty of objects in private trusts

Key Terms and Concepts

• fixed interest
• discretionary interest
• vested interest
• contingent interest
• rule against perpetuities
• beneficiary principle
• certainty of objects