Securing your family’s financial future can be challenging, but if utilised correctly and when appropriate, the establishment of a trust can provide significant benefits. Whether you’re looking to protect assets, plan your estate, or optimise your tax strategies, family and testamentary trusts can play a significant role in your family’s future.
Let’s explore the intricacies of trusts, from the set-up process to the advantageous tax implications and even the lesser-known applications of testamentary trusts.
Part 1: Establishing a Family Trust in Australia
Establishing a trust in Australia is a strategic move that can yield several benefits, including:
A family trust, also known as a discretionary trust, allows you to distribute income and assets among your beneficiaries in a tax-effective manner.
Before setting up a family trust, it's crucial to understand the basics. A trust is a legal arrangement that separates the ownership of assets from the management of those assets. One party, the trustee, holds the assets on behalf of the beneficiaries. This separation allows for discretion and tax efficiency in how assets are managed and income is distributed.
There are also various trust structures you should consider, each with its own specific purpose and legal implications. These include discretionary trusts, unit trusts, fixed trusts, and hybrid trusts.
The Benefits of a Family Trust
Asset Protection
- Family trusts can protect your assets from potential risks such as business failure, bankruptcy, or legal claims. Since the assets are not owned by individuals, they are not as accessible to personal creditors.
Estate Planning
- By establishing a clear plan for the management of assets held in the family trust, a family trust can facilitate a smooth transition of wealth to future generations, reducing potential conflicts amongst family members.
- Assets held in a family trust do not form part of a deceased estate and therefore will avoid the need for probate and keep the assets separate from the estate.
Tax Planning
- Trusts offer a range of tax benefits, including the ability to distribute income to family members in lower tax brackets, therefore reducing the overall tax burden. Also, trusts (unlike companies) are entitled to the CGT discount, therefore making them an attractive option. Unfortunately, like most things, there are some “watch-outs” (s 100A, personal services income rules and Div 7A to name a few), so it pays to seek professional advice.
Flexibility and Control
- As the trustee of a family trust, you have substantial control over the trust assets but are not the legal owner. This can provide significant advantages over traditional ownership structures.
Potential Pitfalls to Avoid with Family Trusts
- When setting up a family trust, there are common mistakes that can have serious consequences. These include failing to fund the trust properly, not clearly defining the trustee's powers and obligations, and overlooking compliance requirements.
Setting Up Your Family Trust
Step 1: Choose the Right Trustee
- Your choice of trustee is critical. Most commonly, trustees are individuals, but they can also be corporate entities. The trustee should be someone you trust implicitly with the management of the trust assets and should be willing and able to act in the best interests of the beneficiaries.
Step 2: Decide on the Trust's Terms
- The terms of your trust, including the rules for asset management and income distribution, should be carefully considered and clearly outlined. Seek legal advice to ensure that the trust deed complies with all relevant laws and meets your specific objectives.
Step 3: Fund Your Trust
- To be operational, your trust must be funded. This involves transferring assets to the trust, which then becomes the legal owner. Funding the trust may have tax implications, so professional tax advice is highly recommended.
Part 2: Navigating Trust Taxation
One of the most significant advantages of family trusts in Australia is their tax efficiency. However, trust taxation can be complex, and it's essential to understand the rules to optimise the benefits.
The Importance of Tax Rates And Strategies To Minimise Tax
- Trusts are a flow through entity for tax purposes, meaning that it is the ultimate beneficiaries of the trust income or capital that are taxed on the their portion of the trust income. As such, the tax rate applied to trust income will depend on the type of beneficiary and their respective tax rate. As such, it might be beneficial to distribute to individuals on lower marginal tax rates (subject to s 100A) or to a bucket company which has a tax rate capped at 30% (subject to Div 7A).
Family Trust Distributions tax
- In some circumstances, it may be necessary for a trust to make a family trust election (FTE). This will be the case where the trust has losses or significant franking credits it’s seeking to distribute. Although a FTE is necessary, it does come with significant restrictions including the ability to distribution outside of the family group. Advice should be sought to determine whether an FTE should be made and the implications of such FTE on future distributions.
Compliance and Reporting Requirements
- Trusts are often subject to ATO scrutiny and compliance action. Trusts are also subject to various additional reporting requirements such as TFN withholding reports, TB statements and annual trustee payment reports.
A tax advisor can provide guidance on managing the tax affairs of your family trust. They can help with compliance, reporting, and strategic tax planning.
Part 3: Utilising Testamentary Trusts in Wills and Estate Planning
Estate planning is an essential aspect of financial management, mainly focused on controlling your assets after you’re gone. A testamentary trust is a powerful tool in this context.
A testamentary trust is a trust that is created under a will and comes into effect upon the testator's death. It can be an effective way to manage assets and income for the benefit of beneficiaries, often including young children.
Benefits of Testamentary Trusts
Incorporating a Testamentary Trust in Your Will
- The process of incorporating a testamentary trust into your will involves careful planning, drafting a valid will, and ensuring that all necessary provisions are included to create and operate the trust effectively.
Tax Implications of Testamentary Trusts
- The tax implications of testamentary trusts can be favourable, especially when providing for minors or for the long-term splitting of income. Given the complexity of tax law, seeking professional advice when establishing and managing a testamentary trust is non-negotiable.
Distributive and Protective Provisions
- When setting up a testamentary trust, the inclusion of distributive and protective provisions - such as who can benefit from the trust, when, and under what conditions - is crucial for ensuring that the trust serves its intended purpose.
Secure Your Family's Financial Future
The world of family trusts in Australia is vast and complex, but the potential for long-term financial security and growth is immense. To ensure you make the most of your trust's potential, it's critical to seek professional advice. Our team of financial planners and tax consultants is ready to assist you in navigating the intricacies of trust establishment, management, and taxation.
Whether you're setting up a trust for the first time or re-evaluating your existing trust structures, BlueRock’s multidisciplinary team can help.
Get in touch today and take the first step towards better financial management and peace of mind that your family’s financial future is in good hands.
