When it comes to planning your financial affairs, the family trust structure is certainly worth considering. It allows for income to be distributed through the family and helps with reducing tax.
Of all the ownership structures available today, the trust is the least well understood. The concept of a trust derives from 16th century England and was used by wealthy land owners to avoid having to pay death duties. While death duties no longer apply in Australia, it remains a very useful legal device which can help families better arrange their financial affairs.
The family trust is commonly perceived as an exclusive vehicle of the super-rich. In fact, even families with modest assets can benefit from a family trust1. They are a great way to protect assets, maximise wealth, reduce tax and provide financial security for family members.
What is a family trust?
A trust typically involves the following:
- The settlor creates the trust by signing a trust deed and making the initial contribution to the fund
- The trustee manages the assets of the trust fund in accordance with the trust deed
- The beneficiaries are entitled to receive payments of income and assets in accordance with the rules of the trust deed
There are several types of trusts but the most popular type is the family discretionary trust. The word ‘discretionary’ as opposed to ‘fixed’ is used, as the trustee has a discretion under the trust deed on how and when to make distributions to beneficiaries. This flexibility is a major advantage from a tax planning and asset protection perspective.
The main advantages of using a family trust
Establishing a family trust to own income producing assets like cash, fixed interest, investment property, shares, managed funds or a business allows you do all of the following
- make provision for your family, including young children and disabled
- attach certain conditions to giving a gift, such as completing education
- protect assets against creditors and lawsuits
- invest through a tax-effective investment structure
- pass wealth through generations (in addition to your will)
- act similar to a superannuation fund but without the regulation and restrictions on what type of assets you can invest in
- pool assets together to maximise investment return
Consider this example of how a family discretionary trust might be used to a family’s advantage:
John and Mary have set up a family trust for the benefit of themselves and their children. They name themselves as trustees, and themselves and their children as beneficiaries. After establishing the trust, over time that they use it to purchase two investment properties and a portfolio of index funds, stocks and bonds.Mary works a regular job and pays high marginal tax rates while john is self-employed and his income is variable. The trust distributes most of the rental and investment income to John to take advantage of his lower marginal rate and then smaller amounts to Mary and their children to reduce the overall tax burden.
One day when John is sued by a creditor and has to declare bankruptcy, the assets of the family trust are protected as they are owned by the trust and not by him personally.
When John and Mary pass away a new trustee is appointed and the children continue to receive distributions from the trust assets.
Setting up a family trust
Despite the perception that family trusts are only for the rich, it’s neither expensive nor particularly difficult to set one up.
The first step is to draw up the trust deed. Consult a legal professional for this to ensure the deed is drafted to suit your circumstances and you receive advice during the process. A settlor, who usually is unrelated and has no further involvement in the trust, will then transfer some property, usually $10, to the trustee. Depending on which state you live in, you may need to pay some stamp duty. The trust is now established.
Managing the trust
Once established you can make gifts to the trust or purchase assets through the trust. These assets will be held by the trustee for the benefit of the beneficiaries who will typically be current and future family members.
The trustee will from time to time make distributions of income, and also capital if desired, to the beneficiaries. This can be done in a way which makes the best use of all beneficiaries’ tax-free thresholds and marginal rates meaning the overall tax paid will be considerably less than if it were taxed in the hands of one individual.
Unlike companies and superannuation funds, private family trusts are almost completely unregulated. There is no public register and they are not obliged to provide annual reports which are great from a privacy perspective. There are no ongoing compliance costs. A trust does, however, need its own Tax File Number and will need to lodge an annual tax return but usually the beneficiaries will pay tax on any distributions received.