The contents do not constitute legal advice, are not intended to be a substitute for legal advice and should not be relied upon as such. You should seek legal or other professional advice concerning any matters you or your organisation may have.
What is a family trust?
A family trust is a discretionary trust established during one's lifetime to administer a family business, oversee investments and support designated beneficiaries, typically family members.
A family trust is not a legal entity but a legal relationship between the trustee and the trust beneficiaries.
However, a family trust is considered a separate entity for tax purposes and usually has an Australian Business Number and a tax file number.
Who are the parties to a family trust?
Settlor – the person who creates the trust by transferring the settled sum (usually $10) to the trustee to benefit those named beneficiaries in the trust deed.
Beneficiaries - persons usually related by marriage (including de facto relationship) and blood ties. Family companies and trusts in which the individual beneficiaries have an interest may also be beneficiaries of the family trust. Charities are often included as beneficiaries of a family trust.
Trustee – may be one or more individuals acting jointly or a company. The trustee holds the assets on trust for the benefit of the beneficiaries and is responsible for managing the assets in the trust. The trustee distributes income and capital to the beneficiaries.
Appointor – may be one or more individuals acting jointly or a company. The role of the appointor is to fire and hire trustees. The appointor, not the trustee, controls the trust.
How is a family trust established?
A family trust is established by a trust deed. The deed is a document that outlines the terms under which the trust operates.
Advantages of a family trust
Asset Protection
Assets held in a family trust are legally separate from the beneficiaries' personal assets. This separation provides a level of asset protection, as the trust assets may be shielded from creditors or legal claims against individual beneficiaries. This can be valuable in protecting family wealth and minimising risks associated with personal liabilities.
The Family Court has wide-ranging powers, though it may be possible to exclude assets held in a family trust from becoming part of the marital pool of assets.
Tax Planning
One of the primary advantages of a family trust is its flexibility in distributing income among beneficiaries. The trustee has the discretion to distribute income to minimise the overall tax liability for the family group. This can be advantageous when beneficiaries have lower tax rates or are tax-exempt entities, allowing for effective tax planning and potential tax savings.
Succession Planning
Family trusts offer a useful tool for succession planning. By transferring assets into a trust, individuals can ensure a smooth transfer of wealth to future generations. The trust structure allows for the continuity of asset management and distribution beyond the lifetime of the original settlor and trustee, providing a long-term estate planning solution.
Assets held in a family trust do not form part of a deceased's estate and can be protected from challenges to the will in Western Australia.
Family trusts also provide an opportunity to hold large assets, such as the family farm, in the family group for longer. Passing control of the family trust to the next generation may delay CGT and transfer duty liabilities.
Flexibility in Distributions
Family trusts provide flexibility in distributing income and capital. The trustee has discretion in determining the timing and amount of distributions to beneficiaries, which can be useful when circumstances change or beneficiaries have different financial needs and personal marginal tax rates. This flexibility allows for customised distributions based on the beneficiaries' circumstances.
Protection of vulnerable family members
Family trusts can be advantageous for minor beneficiaries. Minors cannot directly own or control assets, but a trust allows the assets to be managed and protected on their behalf until they reach a certain age or meet specific conditions outlined in the trust deed.
Family trusts are also useful for protecting spendthrift children and children with addictions. The trustee will usually preserve the capital and distribute only the income to vulnerable beneficiaries.
Privacy and Confidentiality
Family trusts provide a level of privacy and confidentiality. Since the trust owns the assets and the trustee is the legal owner, the details of the trust and its distributions are not publicly disclosed. This can be beneficial for maintaining privacy in wealth and asset ownership matters.
Disadvantages of a family trust
Complexity and Costs
Establishing and maintaining a family trust can be complex and involve legal and administrative expenses. Trust deeds must be carefully drafted, and ongoing compliance requirements must be met. Professional advice from lawyers, accountants, and other specialists may be necessary, adding to the overall costs.
Loss of Control
The settlor relinquishes direct control over assets by transferring assets to a family trust. The trustee assumes control and discretion in managing and distributing the assets according to the trust deed. While this may provide benefits regarding asset protection and succession planning, it also means that the beneficiaries have limited control over the assets held within the trust.
Potential Tax Consequences
While family trusts offer tax planning benefits, tax legislation changes can affect tax strategies' effectiveness. Tax laws and rates can change over time, potentially affecting the tax advantages associated with family trusts. It's essential to regularly review and adapt the trust structure to remain compliant with the current tax regulations.
The trust's income not distributed in the financial year is subject to the top marginal tax rate. The trustee must pay tax at the highest marginal rate on undistributed amounts.
Distributions to minor children are taxed at up to 66%
The trustee cannot allocate tax losses to beneficiaries. The loss will get trapped inside the trust until the trust generates enough income to cover the loss.
Trust Income Attribution
In certain situations, the Australian Tax Office has provisions to attribute trust income back to certain individuals or entities, resulting in unwanted tax consequences. This is known as the "anti-avoidance" rule which prevents income splitting or income diversion for tax purposes. Understanding and complying with these rules is important to avoid potential tax penalties.
Limited Investment Options
Some investments may have restrictions on being held within a trust structure. For example, borrowing to invest in property within a trust can be more complicated or even impossible in certain cases. Certain investment vehicles or financial products may not be suitable or available within a trust structure.
Potential Disputes and Family Dynamics
Family trusts can sometimes lead to conflicts and disputes among family members, particularly disagreements over trust management, distributions or beneficiary interests.
Beneficiaries may have differing expectations or financial needs, leading to conflicts over the amount and timing of distributions. Disputes may also arise if beneficiaries feel distributions are unfair or believe the trustee is not adequately considering their interests.
Disputes can occur if there is a lack of transparency or disagreement regarding the trustee's decision-making process. Beneficiaries may question the trustee's actions, investment choices, or management of trust assets. If beneficiaries perceive a breach of fiduciary duty or a conflict of interest on the trustee's part, it can lead to disputes.
Conflicts of interest can arise if the trustee is a family member or has close ties to the beneficiaries. Beneficiaries may suspect preferential treatment, self-dealing, or actions that benefit the trustee at their expense. These conflicts can erode trust and lead to disputes within the family.
Family trusts can magnify existing family conflicts or trigger new disputes due to underlying family dynamics. Poor communication, lack of trust, sibling rivalry, or disagreements on family values and expectations can all contribute to disputes within the trust management.
It is crucial to have clear communication, transparent decision-making processes, and proper governance structures to mitigate potential family conflicts.
The advantages and disadvantages of a family trust can vary depending on individual circumstances and goals. Seeking professional advice from legal, tax, and financial experts is essential to understand the implications and risks of establishing and operating a family trust in Australia.
Call Crystal Lawyers on 04211 45637 if you have questions.