Family/discretionary trusts: what you need to know
When you are a professional who earns a high income, or the owner of a business, managing your money will start to become a little more complex.
To minimise tax and protect your assets, it can make sense to establish a family trust.
You may have heard someone talking about this concept or had it suggested to you by your accountant. Having a family trust is not an everyday thing, so you’re possibly unsure about why you might need one and what’s involved.
What is a family trust?
Also known as a discretionary trust, a family trust is established to hold a family’s assets or to conduct a family business. It is a way of structuring your assets, so to speak, so you don’t wind up with all your financial eggs in one (unprotected) basket.
A family trust makes sense because of Australia’s scaled income tax system, business environment and legal system. The more you earn, the more tax you pay. A family trust allows you to distribute income and capital in a more tax effective way.
If you’re a business owner, moving assets into a family trust means those assets are less likely to be accessible by creditors in the event of business failure or legal action.
Why establish a family trust?
Trusts are generally established for the following reasons:
- To protect assets – Assets are separate to you so if you face a lawsuit and are personally sued, the contents of the trust account are less likely to be affected.
- To minimise tax – it is possible to use a trust to distribute income, for example to family members who are not currently earning an income. You can distribute funds up to a certain amount without the money being taxed.
- To prepare for retirement – you can strategically use a trust to build your wealth before you retire.
- To invest in shares, property, other investments – it is often more tax-effective to invest within a family trust.
- To minimise Capital Gains Tax – Family trusts can assist in significantly reducing or in some cases eliminating Capital Gains Tax.
- To manage family wealth – family trusts can be very effective for financial management and as part of your estate planning.
Who is included in a family trust?
Generally, a trust includes a few different stakeholders including:
- the appointor (the ultimate ‘controller’ of the Trust)
- the trustee (legal person or entity who has day to day control and oversight of the Trust)
- the settlor (legal person who creates the Trust – generally can’t be a beneficiary); and
- the beneficiaries (the individuals and entities who can benefit from – receive income and capital – from the Trust)
Here is an example:
Philippa is a medical specialist who earns a healthy income but risks being sued for negligence or malpractice. She establishes a family trust with the help of a settlor (her accountant). She asks her father to oversee the trust as the trustee.
Philippa holds her investment properties within the trust. The beneficiaries are Philippa’s family (which can have a broad definition or be specified), and include her three children. As per her instructions, her father is the legal owner (as trustee) of the Trust’s investment properties. However, the income created by these assets can be distributed to Philippa’s children.
When her children turn 18, Philippa distributes $18,200 from the trust to each of them annually. They are able to use this money as tax-free income because it puts them below the tax threshold.
- Philippa is the appointor
- Her father is the trustee (although Philippa could have also appointed a company to act as trustee)
- The settlor is Philippa’s accountant
- Her children are the beneficiaries
If Philippa faces a lawsuit through her work, she can rest assured her investment properties are protected because they are not in her name. The income she distributes to her children through the trust is not taxed because they do not earn any additional income and are below the tax free threshold.
How to set up a family/discretionary trust
Speak with an accountant or financial advisor about whether you should have an individual or company act as trustee for your trust.
From there, you can open a bank account that is clearly identified as being in the name of the trust.
It is important to keep records of the trust’s activity and any money that is allocated.
Should you have a family trust?
A family trust does involve costs to set up and maintain. It is also finite; eventually the assets in the trust will have to be distributed.
A good accountant will notify you when it is time to set up a family trust. It may be because you are running a company with employees and you need to separate your assets from yourself as an individual. It may also be because you are earning a high income and having a trust is a way to help minimise your tax.
Your family trust can also be helpful for succession and estate planning and be used as a way to distribute the income generated by your investments.
The setup process may feel confusing but if you can understand the difference between the appointer (likely to be you), the settlor (your accountant), the trustee (a company or individual) and the beneficiaries (the people in the trust), you’ll be on the right track.
If you are interested in a family trust, it is key to work with a professional who can help you to establish and structure it in the most appropriate and cost-effective way. To find out more, contact Imagine Accounting on 02 9884 7100 or firstname.lastname@example.org