About setting up a family trust

If you want to setup a family trust, it might help to read more about it to understand how it works and what it can do to help your protect your assets and your estate.

Setting up a family trust

Typically a family trust refers to a discretionary trust set up to hold a family’s assets or to conduct a family business. Generally, they are established for asset protection or tax purposes.

Discretionary trusts have features consistent with other forms of trust in that they must have trust property, a trustee and trust beneficiaries.

When setting up a family trust, there is no fixed ownership of the assets inside the trust. What this really means is that property inside the trust is not really owned by anyone – the trustee’s role is really to look after what is in there for the benefit of the beneficiaries.

In a discretionary trust, the trustee also gets to decide which beneficiaries are allocated assets or income from the trust and how much each year. For example, if you have three children who are all of different ages and have different income requirements, one year you may decide to allocate more to one child who is studying at university and then less in subsequent years when they get a full-time job.

The figure below shows the typical structure of a trust.

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The key benefits of a Family Trust

Discretionary trusts can be testamentary, which means you write them into your will to come into effect when you pass away, or inter vivos, which means they are established during your life. What are the benefits? The key benefit to an inter vivos trust is allowing you to minimise your tax position as a family.

This is due to tax being applied to each beneficiary rather than to the trust as a whole. For instance, the trust may generate a certain amount of taxable income which is then distributed to beneficiaries at the discretion of the trustee.

The trustee, instead of allocating the income to the mother or father who may be earning a full salary and therefore already paying tax at a high marginal tax can instead choose to allocate to the children who may be studying or earning considerably less (and therefore attracting a lower marginal tax rate) or an elderly relative who also qualifies for different tax rates.

“This way the income from the trust will have a much lower amount of tax on it,” Boccabella says. “Tax consideration drives a lot of the allocations, which is where the tax minimisation claim comes from.”

Protect your assets with a Family Trust

There are, however, other benefits – a big one being asset protection.

“Say you have a child with a gambling problem or who is not very responsible,” says Boccabella. “If they’re a beneficiary of a fixed trust they actually own something they can lose. In a discretionary trust, the beneficiary has nothing.

“All they have is the expectation the trustee might give them something. Assets inside the discretionary trust are effectively protected from claims against creditors and others.”

Property is often transferred into an inter vivos trust by the people behind its establishment (say Mum and Dad) who are then likely to be potential beneficiaries together with their children.

Jonathan Philpot, a wealth management partner at accounting firm HLB Mann Judd, says flexibility is one of the key advantages offered to those who create a discretionary trust, including planning for income distributions to yourself and your family when you stop working.

Philpot predicts this will become a more popular option given changes to the amount of money you can put into superannuation at a lower tax rate.

Plan for the future

“They will probably become more popular for families that can’t get all their money into superannuation – so in retirement typically they might have a self-managed super fund and also build up wealth in a family trust.”

A key benefit of a testamentary trust is in distributions to children under the age of 18. While adults over 18 qualify for a tax-free threshold (recently raised to $18,200), children under the age of 18 do not, instead being charged the top marginal rate of tax.

A child under 18 receiving income from a testamentary trust, however, does not get charged the penalty tax rate – they qualify for the adult tax-free threshold, which may make the discretionary trust a tax effective means of moving wealth from, say, a grandparent to their grandchildren.

An inter vivos trust does not offer this same benefit to children under 18 so they will generally only distribute to beneficiaries over the age of 18.

Those with farms and properties they want to protect from sale by subsequent generations may also use a discretionary trust to help tie up the property so that children can benefit from income derived without actually transferring ownership.

When can you afford to set up a family trust?

The exact amount you need to set up a trust is subjective, but in order to be cost-effective you will be looking at putting in income or assets of a hundred thousand dollars or more in value.

These assets can be varied, ranging from an investment property to shares or businesses. The primary consideration is the cost of legal and financial advisers of setting up and maintaining the trust to make sure it is on the right track. initial costs can range from $990 and above depending on the structure and advice you need to get it up and running.

Trust deeds can be highly complex documents because they give the impression that no one owns the assets in the trust, while allowing those who put the assets in to maintain some control over them.

“It requires some sophisticated legal drafting to achieve that and while lawyers have that down pat things change and lawyers are adapting as new problems emerge,” Boccabella says.

An employee in your lawyer’s office will usually act as ‘settlor,’ which is the person who technically starts the trust fund with a nominal amount (eg. $10).

What to watch out for

The power vested in the trustee in a discretionary trust clearly makes it important to ensure they act in accordance with the intentions of those behind the trust.

Electing to have a ‘company’ act as a trustee is one way of building more safeguards into the position. Rather than distributions being entirely at the discretion of one individual therefore it is overseen by all the people appointed as ‘directors’ or ‘shareholders’ in the company.

Another option is appointing an ‘appointer’ who provides a watch over the trustee to oversee their decisions and has the power to both appoint and dismiss a trustee. ‘Mum and Dad’ who establish the trust can also be the appointers of the trust.

“It’s also a good idea to have someone independent appointed as a guardian,” Boccabella says.

“Then you can write into the trust deed that if the trustee is going to allocate beyond a certain amount – say $50,000, they have to get consent from the guardian who will have a veto power over that decision.

“You’ve got to build in some controls because say a trustee goes off and allocates a really large amount to one particular beneficiary for whatever reason, that’s the end of the story. Provided there is no fraud you can’t get that money back.”  Source Melanie Timbrell mel@mywealth.com.au

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