Family trusts have come under close scrutiny from government and the Tax Office over the years, but they are still a popular wealth management tool for Australian families. While trusts are set up for a range of reasons, it’s important to understand what they are and what benefits they can provide before making the move.
A family trust is an agreement where a person, group of people or company acts as trustee and agrees to hold assets for the benefit of others, known as the beneficiaries. The trustees control the assets in the trust – which might include property, shares or a business – according to the terms of the ‘trust deed’.
Setting up a family trust is relatively straightforward but there are strict rules governing who can benefit and how any income is to be distributed.
A fairly typical scenario is one where the trustees are Mum and Dad or a company one or both of them owns and controls. Their children or other dependents are the likely beneficiaries.
Any income earned by the assets in the trust can only be distributed to people who qualify as beneficiaries under the terms of the trust deed. In addition to children, beneficiaries can be a spouse or ex-spouse, parents, grandparents, siblings, nephews and nieces. Beneficiaries can also be related companies or charities.i
The trust must also file its own annual income tax returns.
Income distribution
The income distributed by your family trust could come from dividends from shares, rent from property or capital gains. Any income not distributed is taxed in the hands of the trustee at the top marginal tax rate, so there is a big incentive to distribute every year.
One of the many appeals of family trusts is that the trustee has full discretion over which beneficiaries will receive income and in what proportion. This offers a high degree of flexibility but it can also lead to disputes over favouritism.
As income is taxed in the hands of beneficiaries, one popular strategy is to direct income to those on the lowest personal marginal tax rates. For example, if parents want to support a child through university this can be a tax-effective way to do it.
The tax-effective nature of family trusts has also put them on the radar of the Tax Office. In recent years it has made changes to wind back some of the earlier tax benefits such as the tax-free threshold to minors.
Asset protection
Tax benefits are far from the only advantage of a family trust. They can also put the trust’s assets at arm’s length from creditors and potential claimants.
Legally speaking, the trustee might be the legal owner of assets inside the trust but they are not the beneficial owner.ii What’s more, beneficiaries don’t own or have an interest in the property held in the trust.
Say a beneficiary owns a café that is forced to close down owing money. Creditors would struggle to make a claim on any assets held by the family trust.
Some families use trusts to protect an adult child’s inheritance from ‘gold-diggers’ or a relationship breakdown. That’s because the assets within a family trust would generally not be counted in a property settlement.iii
Protecting kids from themselves
In other cases, parents may worry that one or more of their children are spendthrifts or not up to the task of managing a substantial inheritance. Holding assets in a family trust where they can’t be sold off can help alleviate some of those concerns.
Whether or not a family trust is the best place to accumulate and hold assets will depend on the assets involved, whether you are acting as an individual or a company, the ages and relationships of your beneficiaries and your willingness to take responsibility for maintaining and operating the trust appropriately.
If you would like to discuss the potential benefits of a family trust, please give us a call.