Family trusts often sound like something reserved for the wealthy, yet most people don’t know how they operate, or why they might be relevant to their own financial circumstances. Certainly, we encounter many prospective clients who have heard of Trusts (or may even have their businesses set up via Trust) but aren’t aware of the full range of benefits they can offer.
A family trust, often called a discretionary trust, is a legal arrangement designed to hold and manage assets for the benefit of family members. It is established through a trust deed, which outlines the rules and responsibilities of the trust. The main roles within a Trust include the trustee, who legally owns and manages the assets, and the beneficiaries, who receive income or capital distributions at the trustee’s discretion.
Unlike a company, a trust is not a separate legal entity but rather a relationship governed by the trust deed and relevant legislation. Trustees have significant control over how income and capital are distributed, which provides flexibility in managing family wealth. To qualify as a family trust for tax purposes, the trustee must make a Family Trust Election with the ATO, which can easily be arranged with an accountant. This election allows access to certain tax concessions, such as the distribution of franking credits to beneficiaries.
How does a family trust operate?
One of the most attractive benefits of a family trust is tax efficiency. Trustees can allocate income among beneficiaries who are in lower tax brackets, reducing the overall tax burden for the family.
To illustrate this, suppose a family trust earns $100,000 in net income for the year. The trustee has discretion to distribute this income between two beneficiaries, which happen to be a married couple. One partner earns $200,000 salary and is already in the top tax bracket, while the other partner is a homemaker and has little or no other income.
If the trustee distributes the $100,000 Trust income to the lower-income partner, the overall tax liability is significantly reduced. The lower-income partner’s share will be taxed at much lower marginal rates, while the higher-income partner avoids paying 47% tax on the full amount, saving thousands of dollars in the process.
The tax benefits of Trust ownership alone provide a strong case for their use for investing in shares and property. Furthermore, Trusts are also eligible for the 50% Capital Gains Tax (CGT) discount for assets held longer than 12 months, making them a preferred structure to own investments compared to companies and personal ownership in many circumstances.
Asset protection is another strong advantage, as assets held in a trust are generally separate from personal ownership, which can provide a layer of protection against creditors or legal claims. This makes trusts appealing for business owners or professionals exposed to financial risk. Additionally, trusts can sometimes help safeguard family wealth during life events such as divorce or bankruptcy.
Family trusts also play an important role in estate and succession planning. They allow for the smooth transfer of wealth across generations without the delays and costs associated with probate, as Trustees can manage assets according to the family’s long-term goals, purpose and legacy objectives. For families operating businesses, holding the business within a trust structure can maintain operations seamlessly even when ownership changes.
Is there any new regulatory risk?
Recent years have seen significant regulatory changes impacting family trusts. The ATO has tightened anti-avoidance measures, and Trustees must now ensure that all distributions are genuine and properly documented to avoid penalties, instead of just ‘paper transactions’ where funds are not genuinely distributed to beneficiaries.
Another critical area is the Family Trust Distribution Tax (FTDT). Distributions made outside the specified family group attract a tax rate of 47%, which can result in significant liabilities if not managed carefully.
Recent court decisions such as the Bendel case have also influenced how unpaid present entitlements (UPEs) are treated under Division 7A rules. Specifically, the Federal Court found that UPEs to corporate beneficiaries do not constitute Division 7a loans, as they create an obligation to pay a beneficiary rather than an obligation to repay, overturning a longstanding ATO position and removing the need for trustees to implement cumbersome Division 7a loan agreements for these types of distributions. While the ATO is looking to issue new guidance around this issue, it does remove some administrative burden for individuals in this particular circumstance.
Additionally, there are numerous proposed reforms on the horizon aimed at closing loopholes and limiting the tax advantages associated with discretionary trusts, so it is best practice to stay up to date with the latest legislation.
How can we help?
Family trusts offer significant advantages in tax planning, asset protection, and wealth transfer, making them a valuable tool for many Australian families. As a multi-award winning financial planning firm, Boutique Advisers Private Wealth can assist you with establishing and managing family trusts effectively.
Importantly, we work collaboratively with your accountant or tax specialist throughout the process to ensure the trust structure is aligned with your overall financial strategy and complies with all regulatory requirements. This partnership approach helps deliver a seamless experience and optimal outcomes for your family’s wealth management.
Ready to explore whether a family trust is right for you? Connect with one of our experienced advisers.
