Setting up a family trust in Australia is a well-known method for managing wealth, protecting assets, and planning for tax efficiency. Whether you’re looking to secure your family’s financial future, protect assets from creditors, or optimise your tax position, family trusts can offer several financial benefits.
What is a Family Trust?
A family trust is a type of discretionary trust commonly used by families to manage and protect assets. It’s a legal arrangement where assets are held and managed by a trustee for the benefit of beneficiaries, who are usually family members.
Unlike other trusts, a discretionary trust means that the trustee has the discretion to decide how much income or capital to distribute to each beneficiary each year.
Key Roles of Different Parties in a Family Trust:
- Settlor: The person who sets up the trust by contributing a nominal sum (usually $10 or $100).
- Trustee: The individual or corporate entity responsible for managing the trust and its assets.
- Beneficiaries: The individuals who benefit from the trust.
- Appointer: The person who has the power to appoint or remove trustees.
Key Features of a Family Trust
A family trust operates according to a legal document known as a trust deed, which outlines how the trust is managed. Here are the essential features:
a. Discretionary Nature: The trustee has complete discretion on how the trust’s income and capital are distributed among beneficiaries. This flexibility allows trustees to optimize distributions based on the beneficiaries’ needs and circumstances.
b. Trusteeship: A family trust can have an individual trustee or a corporate trustee. While individual trustees are simpler, a corporate trustee can provide more protection and continuity, especially if the trust operates for many years.
c. Lifespan: A family trust typically has a maximum lifespan of 80 years, after which the assets must be distributed to beneficiaries or transferred to another trust.
d. Beneficiaries: Beneficiaries can include current and future family members, such as children, grandchildren, and spouses. The trust deed typically defines beneficiaries broadly to cover multiple generations.
Steps to Set Up a Family Trust
Establishing a family trust requires vigorous planning and compliance with legal requirements. Below is a detailed step-by-step process:
a. Decide on Key Roles: You must decide who will act as the trustee, beneficiaries, and appointer For a corporate trustee, a company must be formed before the trust is established.
b. Draft the Trust Deed: A trust deed is a legally binding document that sets out the terms and conditions of the trust, including:
- Who the beneficiaries are
- How income and capital can be distributed
- The powers and duties of the trustee
- The lifespan of the trust
A solicitor, trust specialist, or Accountant typically drafts this document to ensure it complies with relevant laws.
c. Settlor and Initial Contribution: The trust is created by a settlor – an independent third party, such as an accountant – making a nominal contribution. The settlor can not be a beneficiary of the trust.
d. Appoint Trustees: The trustees are appointed to manage the trust’s assets. It’s common to appoint family members as trustees, but a corporate trustee can provide additional benefits, such as limiting personal liability and asset protection.
e. Register for a Tax File Number (TFN): A family trust needs a Tax File Number (TFN) to lodge tax returns.
f. Open a Bank Account: The trust should have its own bank account to manage the trust’s financial transactions, separate from the personal accounts of the trustees or beneficiaries.
g. Optional: Corporate Trustee: If using a corporate trustee, a company must be established to act in this capacity. This company needs to be registered with ASIC and adhere to corporate regulations.
Taxation of Family Trusts
One of the key benefits of a family trust is the flexibility it provides in tax planning. Family trusts allow trustees to distribute income to beneficiaries in a tax-efficient manner.
a. Distributing Income to Beneficiaries: Each year, the trustee can distribute trust income to beneficiaries. The income is then taxed in the hands of the beneficiaries, often at lower marginal tax rates if they have little or no other income. For example, if the beneficiaries include adult children with no or low income, the trustee can distribute a portion of the trust’s income to them, taking advantage of their lower marginal tax rates.
b. Tax-Effective Income Distribution: Income distributed to beneficiaries is taxed at their personal income tax rate. If a beneficiary is a minor, special tax rates apply, and income is taxed at higher rates. Distributions to minors, generally under the age of 18, are taxed at penalty tax rates to prevent income splitting.
c. No Tax on Undistributed Income: If the trust income is not distributed by the end of the financial year and retained by the trust, it is taxed at the highest marginal tax rate (47% as of 2024), making it important to distribute all income to avoid punitive tax rates.
d. Capital Gains and Franking Credits: Trusts can also distribute capital gains and franking credits from dividends to beneficiaries. Beneficiaries who qualify for capital gains tax (CGT) concessions can reduce the tax payable on these distributions.
Asset Protection Benefits of a Family Trust
One of the most significant benefits of a family trust is its ability to protect family assets from creditors, lawsuits, or other claims.
a. Separation of Ownership: Assets in a family trust are legally owned by the trustee, not the beneficiaries. This separation means that if a beneficiary faces personal bankruptcy, creditors cannot claim the trust’s assets.
b. Protection from Divorce Settlements: In cases of marital breakdown, assets held in a family trust may be more challenging to claim as part of divorce settlements. Although family law courts can consider trust assets when dividing marital property, the trust provides an additional layer of protection to the assets.
c. Business Risk Mitigation: If a beneficiary operates a business with financial risks, placing assets in a family trust can protect those assets from being accessed by business creditors.
Succession Planning with a Family Trust
A family trust is an excellent tool for succession planning, ensuring the smooth transfer of wealth from one generation to the next.
a. Continuity Across Generations: A trust can hold assets for multiple generations, ensuring that family wealth is preserved and passed on according to the family member’s wishes. The trustee can manage the trust for the benefit of future generations without the risk of assets being misused, liquidated or squandered.
b. Appointing a Successor Trustee: The trust deed can specify how new trustees are appointed when the original trustee dies or is no longer able to manage the trust. This flexibility allows the trust to continue for its maximum lifespan (up to 80 years).
c. Control Over Inheritance: The discretionary nature of a family trust allows the trustee to control how and when beneficiaries receive income or capital distributions. It is particularly useful in situations where beneficiaries may not yet be ready to manage large sums of money responsibly.
Potential Drawbacks and Limitations of a Family Trust
While family trusts offer many benefits, there are also some potential drawbacks:
a. Complexity and Cost: Setting up and maintaining a family trust can be complex. The trust deed must comply with legal and tax requirements, and trustees must manage the trust in accordance with the law. There are also ongoing administrative costs, such as accounting fees and trustee fees.
b. Distribution Restrictions: Although trustees have discretion over distributions, certain legal rules (such as tax on minors) limit how income can be distributed. Trustees must be careful to comply with these restrictions to avoid penalties.
c. Loss of Personal Control: Once assets are placed in a family trust, the original owner no longer has personal control over them. Trustees must act in accordance with the trust deed and the interests of beneficiaries, which can limit an individual’s ability to manage the assets freely.
Is a Family Trust Right for You?
A family trust is most beneficial for families with significant assets or complex financial situations, such as:
- Families with investment properties or a family business
- Families looking for asset protection or succession planning
- Individuals with significant taxable income who wish to optimise their tax position
A family trust is a powerful tool for asset protection, tax planning, and wealth management. It provides flexibility in distributing income and capital to family members, protects assets from external claims, and ensures a smooth transfer of wealth to future generations. However, setting up and managing a family trust requires careful planning, legal guidance, and ongoing administration.
Before setting up a family trust, it’s crucial to consult with a legal or financial professional who can tailor the trust to your specific needs and ensure that it complies with all relevant laws and regulations.
If you need assistance setting up a family trust, contact Budgetwise Accountants.