Understanding Family Trusts: How They Can Protect and Grow Your Wealth

Some of 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.

ADVANTAGES

Tax efficiency

• A trust does not pay tax on income or capital gains that are distributed to the beneficiaries. 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.

Asset protection

• Family trusts are popular structures for protecting family wealth from the risks of bankruptcy or litigation. As the assets of the trust belong to the trustee and not the individual 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 death.

DISADVANTAGES

• 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 income 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 and 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

• family businesses are often owned via 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.

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.

THE BENEFICIARIES

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).

THE TRUSTEE

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 is often family members or a company with the family members acting as directors.

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.

Want to feel confident about your financial future?

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For more of the guidance you need to protect your wealth with confidence, book a chat with our team.

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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.