The main reasons why family trusts are set up are:
to hold family assets such as a business or property
to protect assets from creditors and litigation
for tax efficiency
to avoid challenges to a family member’s will
to protect vulnerable family members
A trust is a legal relationship where one party holds something for the benefit of another. The person who holds the trust property is called the trustee, whilst those who receive the property are called beneficiaries. The rules of the trust (what it can and can’t do) are documented in the trust deed.
Trusts can be a helpful way to structure your family finances, especially if you run a business or want to distribute property to family members.
Administration of a family trust takes a bit of time and will incur admin costs so you want to make sure that the tax savings and other benefits justify the costs.
A trust does not pay tax on income or capital gains that are distributed to the beneficiaries, but does have to pay tax on undistributed income or capital gains. The trustee is generally able to distribute trust income to as many beneficiaries as possible, and in proportions that take best advantage of those beneficiaries' personal marginal tax rates. The beneficiaries then pay the tax on distributions made to them. This can be particularly helpful in supporting adult children who are studying or older parents who are retired as they are likely to be in a low tax bracket.
Trusts also allow for capital gains to be distributed to beneficiaries and the gains retain their eligibility for the 50 per cent capital gains concession if the investments are held for more than 12 months. However, capital losses cannot be distributed.
Be aware that penalty tax rates apply to unearned income for minors – those aged under 18. Minors can only receive investment income up to $416 before being hit with higher tax rates. This is to ensure adults don’t try to avoid paying tax by directing their income to their children.
Family trusts are popular structures for protecting family wealth from the risks of bankruptcy or litigation. Because the assets of the trust belong to the trustee and not the individual beneficiaries they cannot generally be used to pay the creditors of individual beneficiaries (unless assets were contributed to the trust with the intention of defeating creditors). So, if a family member is “at-risk” of being sued or going bankrupt, then they are better to hold family assets in a family trust so that the family assets cannot be attacked.
Holding assets in a family trust can also assist in avoiding challenges to a Will since any assets held in the family trust will not form part of a deceased estate. Retaining assets within a family group can also be a motivator for holding assets in a trust, for example, a family farm.
Trusts are often used in estate planning because they provide more certainty, by putting in place a structure that continues after the death of a benefactor or beneficiary.
Protecting vulnerable family members
Family trusts can be beneficial for protecting vulnerable beneficiaries who may make unwise spending decisions if they controlled assets in their own name. A spendthrift child, or a child with a gambling or drug addiction can have access to income but no access to a large capital sum that could be quickly spent.
there are costs involved for establishing and maintaining the trust, typically around $2,500 to establish and $2,500+ pa in accounting fees
trusts can be complex, creating an additional administrative burden that, if not properly embraced, can weaken the trust and lead to it failing at the time it is really needed
a family trust can’t distribute capital or revenue losses to its beneficiaries. As a result, should a trust incur a net loss, its beneficiaries won’t be able to offset that loss against any other assessable income that they may derive. Losses are however retained to be offset against future income or capital gains.
any income earned by the trust that is not distributed is taxed at the top marginal tax rate (currently 47.5%)
distributions to minor children are taxed at up to 66%
running the trust can become particularly difficult when family disputes arise.
WHO CAN A FAMILY TRUST BENEFIT?
A financial adviser who is across your entire wealth landscape will be able to tell you if a family trust is valuable to you, but as a guide a family trust may benefit you if you fall into any of the following categories.
individuals requiring asset protection against creditors
property owners with several properties and who wish to manage land tax more efficiently
farmers who want to manage the succession of farming land to the next generation
investors who have experienced a relationship breakdown and require protection of assets
benefactors who expect challenges to estate planning
individuals in aged care who wish to reduce the income-tested fee and impact on the age pension.
family businesses are often set up as a trust so that each family member can be made a beneficiary without having any involvement in how the business is run. The key in setting up trusts for family businesses is flexibility. Trusts allow parents to distribute wealth to children in a more measured and controlled fashion. A family business can represent the bulk of the family’s wealth. The transfer of ownership of that asset from one generation to the next in a tax-efficient manner can very often be the difference between keeping the business in the family or being forced to sell it. The bigger the business, the more a trust can help owners control how the business is run, by whom and for what purposes after they retire or die. In some cases, one child may be interested in running the business, while others want to sell it.
DISTRIBUTION FROM THE FAMILY TRUST
A crucial part of the administration of the trust is the annual distribution of any income earned by the assets in the trust to those who qualify under the terms of the trust deed to be beneficiaries.
Income could be dividends from shares, rent from property or capital gains (complete with the 50 per cent discount for assets held for more than 12 months).
Undistributed income is taxed in the hands of the trustee at the top marginal tax rate, giving a strong incentive to family trusts to distribute fully the trust's income before the financial year-end.
Take care in choosing which beneficiaries receive what, as penalty tax rates can apply to distributions made to minors.
The percentage of income distributed to each beneficiary is often part of broader tax planning and will depend on the beneficiary's individual income and tax rate.
The ATO requires written proof of the distribution being made prior to the end of the financial year. Trustees are required to document the distributions in a "resolution" of the trustees of the trust.
TO CREATE A TRUST YOU NEED
a settlor – the person who establishes the trust and gifts the settlement sum to the trust (usually a nominal amount)
an appointor – the person or entity with the right to appoint or remove the trustee
trustees or directors of a corporate trustee - who make decision which control the trust
governing rules (a trust deed)
identifiable beneficiaries (members)
an ABN and TFN for the trust
a bank account for the Trust. It should be opened in the name of the trustee ‘as trustee for the trust.’ The first deposit into the account should be the settlement sum. This sum should be there before any other deposits or transactions are made.
Beneficiaries possess a right (at the trustees discretion) to receive trust income or trust property but they do not have the right of control or ownership. The trust deed determines the extent of their entitlement (income, property, or other) and the nature of their entitlement (fixed amount or percentage or at the trustee’s discretion).
A Trustee is appointed to each Family Trust. Their job is to manage the assets held by the trust in the best interests of the beneficiaries. They need to follow the rules set out in the Trust Deed.
A trustee can also be a beneficiary of a trust but cannot be the only beneficiary.
A trustee can be a non-professional individual (family member), a professional individual (such as a financial adviser, lawyer or accountant), or a corporate fiduciary (such as a bank or corporate advisory firm). They need not be related, and in some circumstances it is inadvisable to select a close relative. You need to find someone with integrity who is also aware of all trustee obligations eg. good faith, duty to act in the best interest of beneficiaries, etc.
THE TRUST DEED
A trust deed is a legal document that sets out the rules for establishing and operating your trust. It includes such things as the trust’s objectives, who can be a member and whether benefits can be paid as a lump sum or income stream.
The trust deed must be:
prepared by someone competent to do so as it's a legal document
signed and dated by all trustees
properly executed according to state or territory laws
regularly reviewed and updated as necessary
WHO CAN HELP?
Typically your accountant or financial adviser are the best placed to identify whether or not a family trust would be beneficial in your circumstances. Ask your accountant or financial adviser for a cost / benefit analysis before you make the decision to form a family trust.
Your accountant would typically handle the administration of setting up a standard family trust, then advising on the most effective distribution strategies.
If your family trust needs special or unusual clauses or involves complex assets, you should engage a lawyer to specifically tailor the trust deed to your particular circumstances.
WHAT DOES IT COST TO SET UP?
Like any type of legal documentation, setting up a family trust does cost money. In fact, the initial startup cost can be approximately $2,500 and then the same amount again annually in maintenance-type fees. These types of ongoing costs are necessary because there are significant rules and regulations around family trusts, including meeting the requirements for asset protection and all the Australian Taxation Office registrations on ABN as well as Tax File Numbers. Family trusts can also attract stamp duty with the cost varying from State to State:
The family trust information here should be considered general in nature, and in no way interpreted as legal advice. You should always seek your own independent legal, accounting and financial advice before ordering any of these types of complicated legal structures.