This information is accurate as of 17 April 2019 and is subject to change. This is general information only for educational purposes and no one should rely on this advice alone.
Want to feel more confident about the protection of your assets?
You might want to consider starting a discretionary trust.
A discretionary trust (often colloquially called a family trust) is normally set up for the protection of a family’s assets, although some families create a trust to effectively manage their income and hold their investments.
When a trust is created, assets are placed in the care of a third party, referred to as a trustee, who manages the trust on behalf of the family’s beneficiaries. This removes the burden of individual ownership. Often, the trustee is a company controlled by individuals in the family group.
Most trust deeds have an appointor – the person who can appoint or replace the trustee. This person (or persons) play a powerful role in the safeguarding of the trust as they can replace the trustee if the trustee is not fulfilling their role.
The trustee is responsible for managing and investing the assets for the benefit of the beneficiaries; distributing the income of the trust each year; and when the trust comes to an end, distributing the capital of the trust.
There are various pros and cons to setting up a discretionary trust. In this article, we share three pros and two cons to opening a trust, plus provide some advice about starting a trust with your family.
A few technical notes before we begin…
- While a trust might be called a “family trust”, a trust is only a “family trust” for taxation purposes and only if a valid family trust election has been made.
- Family trust elections are particularly relevant where a trust makes a loss or distributes franked dividends/distributions.
- A detailed analysis of family trust elections is outside the scope of this article.
- This article is valid as of 17th April 2019 and is subject to change.
Pro #1: Asset protection in the event of divorce or bankruptcy
Normally, when a person experiences divorce or bankruptcy, their assets are put at risk of loss. Assets can be seized by Order of the Court or, alternatively, by the enforcement of a Court Judgement.
A family trust can help to protect assets like money, businesses and investments among other things. A fully discretionary trust (i.e. no default beneficiaries) can stop beneficiaries and creditors barging in to split the assets in the event of divorce or bankruptcy.
In a fully discretionary trust, the trustee decides who has access to the assets and can split the trust accordingly. It is worth noting that the Family Law Courts of Australia will consider any assets owned by discretionary trusts to which a spouse is a beneficiary as a form of financial resource and can factor this into their judgements regarding the split of assets.
In the case of bankruptcy, trusts may offer some protection provided the bankrupt person is not the appointor or trustee and provided the bankrupt person has not transferred wealth to the trust with the intention to defeat creditors.
Pro #2: Reduced tax when purchasing investments
A family trust can be used to purchase investments – and there are legitimate tax benefits for doing so.
If a trust acquires investments such as shares in listed companies or units in trusts, the income on those investments is paid to the trust who then decides who to distribute this income to in any particular year.
If the investment is held in the trust for more than twelve months, the gain on the investment is currently eligible for a 50% capital gains tax discount upon sale, provided the capital gain is distributed to an individual beneficiary.
One of the most influential reasons to open a family trust for investment ownership is protection from creditors. When investments are included in a discretionary trust, the investment technically belongs to the trust rather than the beneficiaries – so if anyone in the family goes bankrupt, creditors can’t seize the investments.
Whilst land/property/buildings can be acquired in a discretionary trust in NSW land tax will apply to all of the land value. Individuals have a threshold of land ownership which is exempt and this does not apply to discretionary trusts. Therefore personalised advice should be sought prior to planning to acquire property in a trust.
Pro #3: Perfect for retirement planning and complementing superannuation
The aim of most working Australians is to have a comfortable retirement. Naturally, you want to enjoy the autumn years of your life! Most Australian workers build their retirement funds through superannuation – and a discretionary trust is often a perfect way to supplement these earnings.
Unlike superannuation funds, trusts have no contribution limits, no restrictions on where you can invest (unless specified by the trust deed) and no borrowing limits. You can give and take from a trust as needed, so you have increased financial flexibility throughout life.
A trust can also be useful for passing on your wealth after death. As a trust is not owned by an individual, the trust and trust assets cannot be willed by that individual therefore keeping the assets out of the estate. Control of the trustee may be able to be passed down by dealing with the ownership of the trustee company, or nominating a subsequent appointor for the trust.
This enables you to nominate who you want to manage the trust after your death and allows assets to continue in their existing structure without stamp duty and income tax complications.
Con #1: Trust losses cannot be distributed
One of the major inconveniences of a trust is how capital or revenue losses are handled. Losses cannot be distributed among beneficiaries – instead, the loss is trapped inside the trust and has to be funded with after-tax income.
For example, imagine a couple purchases an investment property and is receiving rent from tenants. However, after some time, they find out the rent being paid isn’t enough to cover interest and other costs related to the house, so the loss gets trapped inside the trust.
In order to ensure the trust has sufficient cash flow to pay expenses the family members benefiting from the trust may need to loan money to the trust.
In order to carry forward the loss and offset it against future income, the trust may need to make a family trust election to pass the loss tests which can limit potential beneficiaries in the future.
Con #2: Trusts have an expiry date
You’d think a trust would be an indefinite part of your family’s security. However, nothing lasts forever and thanks to the “rule against perpetuities”, most trusts have a shelf-life of 80 years.
This means after 80 years (or whichever date is specified in your deed), your family trust will vest and the assets will automatically be distributed among the beneficiaries. In many cases, this triggers a capital gains tax or GST event, which means significant taxation could be owed to the Federal Government.
Naturally, this has caused some anxiety for baby boomers and investors around Australia! Unfortunately, once a trust has been created, it is very difficult to change the vesting date to a date later than specified in the trust deed. Legal advice is required in this regard.
If you’re thinking about starting a trust or you’re concerned about the lifespan of your existing trust, we recommend getting in touch with a financial planner or an accountant for more advice on the issue.
There are various pros and cons to starting a family trust – so talk to a professional about your options first
A discretionary trust can be a worthwhile structure for families who want to protect and invest in their wealth. A trust can be used to protect assets like money, businesses and investment properties, plus a trust can help protect against divorce, death and bankruptcy.
However, trusts can also be complicated and have a specific shelf-life of up to 80 years, meaning the protection of family funds isn’t indefinite – even after paying administration and set-up fees!
Starting a trust has advantages and disadvantages for all families – so we recommend booking in some time to discuss options with one of our accountants.
At A Squared Advisers, we have extensive experience in structuring for wealth accumulation, so we can provide the expert advice you need to confidently start or manage a family trust.
Get in touch with the team from A Squared Advisers in Newcastle to discuss the pros and cons of starting a family trust.