There's a common saying that you should start most endeavours with the end in mind, and this is especially true for property investment.
Unfortunately, too many investors begin their journey without considering the best ownership structure and wind up owning their entire portfolio in their own name.
While this is perfectly fine in many circumstances, there are other options out there that may be better for you and your family.
And that’s why an family trust has become a popular estate planning tool among many families - because it gives family members a way of passing control of their assets to the next generation while also getting excellent tax benefits and asset protection.
But, as with any investment strategy, family trusts do also come with some risks and disadvantages.
Here’s an overview about everything you need to know about family trusts, how to set one up, and what to look out for.
What is a family trust?
The term ‘family trust’ refers to a discretionary arrangement set up to hold family assets and/or manage a family business.
The beneficiary is a person or company, normally a family member such as a spouse or child, who has an entitlement to the income or capital from the trust.
The setup allows the trustee or trustees of the family trust to have complete discretion on how its net income and capital (or losses) are distributed to the family group.
They tend to be taxed on the net income of a trust, based on their share of the trust’s income which means that generally, they are established for asset protection or tax purposes.
What is the purpose of a family trust?
The main purpose of a family trust is to transfer assets from one person to another, usually avoiding having them go through probate when you die.
Trusts can hold different kinds of assets - from property to investments or even cars.
The other purpose of a family trust is to protect assets from creditors and legal stoushes.
Family trusts are also useful for estate planning purposes.
Through a family trust, the ownership of assets such as a share portfolio or holiday house can continue on uninterrupted even when a key family member dies.
How does a family trust work?
The trustee is responsible for managing the trust's tax affairs, including registering the trust in the tax system, lodging trust tax returns and paying some tax liabilities.
Beneficiaries (except some minors and non-residents) include their share of the trust's net income as income in their own tax returns.
There are special rules for some types of trust including family trusts, deceased estates and super funds.
What are the benefits of a family trust?
Family trusts offer a variety of benefits, that's why plenty of people choose to set one up.
Some of the benefits of setting up a family trust include:
- Asset protection – such as the ability to buy a house for a child to live in without ownership being forfeited because the ownership remains within the trust.
- Minimising tax – trust distributions means lower incomes for tax purposes.
- Planning for retirement savings – the flexible structure of trusts presents an opportunity to accumulate wealth that can supplement superannuation savings.
- Flexibility to invest in property – unlike super, holding assets within a trust doesn’t have the same strict rules.
- Capital Gains Tax (CGT) – family trusts have CGT advantages compared to companies. This is because the 50 per cent discount factor on capital gains received for assets retained for at least a year applies to trusts but doesn't apply to companies.
What are the risks of a family trust?
While there are some significant benefits to setting up a family trust, as with all investment strategies, there will always be some element of risk.
One of the major risks or disadvantages of a family trust is that it can't distribute capital or revenue losses to its beneficiaries.
As a result, should a trust incur a net loss, its beneficiaries won't be able to offset that loss against any other assessable income that they may derive.
Other risks and disadvantages to setting up a family trust can include:
- Tax risks – tax avoidance can be a risky business and a tax accountant should be consulted before you unknowingly get yourself in trouble.
- The name holding the assets – the trustee is the legal owner and this individual’s name will appear across all documentation.
- Loss of ownership of assets – personal ownership of property is lost when managed through a trust.
- Additional administration – this costs time and money long-term.
Of course, with any type of legal documentation or taxation advice, it's always advisable to consult the experts to best understand your individual situation.
Another risk is that many trusts are drafted to have an end date and as such can create taxation issues down the line.
The professionals you use should be able to draft a trust with no end date and a capacity to protect the assets to the direct descendants of the original beneficiaries i.e. safe from ex spouses.
How do I set up a family trust?
Setting up a family trust is fairly straightforward and can usually be completed within one month.
Here are the steps you’d need to take:
Choose your trustees and beneficiaries
Who will act as your trustee(s) and who will be your beneficiary/beneficiaries?
A trustee is a person or entity who legally owns and exercises the day-to-day control of the trust so it is important that you choose someone that you believe is reliable.
You can choose an individual trustee which has low set-up and maintenance costs, or a corporate trustee which has the advantages of additional protection of trust assets and ease in succession planning.
A beneficiary is the person, people or entities that will benefit from the trust.
Draft the trust deed
Once the key decisions around selecting the trustee and appointor of the family trust is made, the next step is to engage a lawyer with expertise in trust law to create the trust deed.
Many accountants will provide family trust set up services, however they are not themselves drafting the trust deed, they outsource it to a legal document provider (i.e. they use a legal template).
Ideally a lawyer should be involved with overseeing the trust establishment structure with the assistance and advice of an accountant.
Settle the trust
The settlor is the person who establishes the trust – they 'settle' an amount on the trust and set up the terms of the trust through the trust deed. The amount settled on the trust is usually a fairly nominal amount – e.g. $10.
The settlor is usually someone unrelated to the beneficiaries of the trust, such as an accountant or close family friend. For tax reasons, the settlor should not be a beneficiary of the discretionary trust. The settlor usually has no further involvement with the trust after the initial settlement.
Sign the trust deed
The trustee(s) must hold a meeting accepting their appointment as trustee(s) of the trust. Here, they must agree to be bound by the terms of the trust deed.
Have the trust deed stamped
Trust deed stamping a process to officially create the trust entity.
In Queensland, your trust deed does not need to be stamped. However, stamping is a requirement in other states such as Victoria and New South Wales.
If you do not get your trust deed stamped within the relevant time frame, there may be late fees and penalty interest payable to the relevant revenue office.
Apply for an ABN and TFN
Once the family trust has been set up, you’ll need to apply for an Australian Business Number (ABN) as well as the Tax File Number (TFN).
Set up trust bank account
A bank account should be opened in the name of the trustee as trustee for the family trust.
A bank will typically require the ABN and TFN for the trust as well as a copy or certified copy of the family trust deed.
What does it cost to set up a family trust?
Like any type of legal documentation, setting up a family trust does cost money.
In fact, the initial start-up cost can be about $2,500 and then maybe the same amount again annually in maintenance-type fees depending on the activities of the trust.
These types of ongoing costs are necessary because there are significant rules and regulations around family trusts, including meeting the requirements for asset protection and all the Australian Taxation Office registrations on ABN as well as TFNs.
Family trusts can also attract stamp duty with the cost varying from state to state:
- WA – Nil
- ACT – Nil
- NSW – $500 (due 3 months of the date of the deed)
- NT – $20 (60 days of the date of deed)
- QLD – Nil
- SA – Nil
- TAS – $20 (due 3 months of the date of the deed)
- VIC – $200 (due 30 days of the date of the deed)
How is a family trust taxed?
Adult and company beneficiaries pay tax on their share of the trust's net income at the tax rates that apply to them, according to the ATO.
The trustee pays tax on behalf of non-resident beneficiaries and those who are minors, based on their share of the trust's net income.
These beneficiaries may need to declare their share of the trust's net income in their own income tax returns, and can claim a credit for the tax paid on their behalf by the trustee.
Higher rates of tax apply to most trust distributions to minors.
If there is any part of the trust's income for which no beneficiary is entitled, the trustee is taxed on the corresponding share of net income.
If there is no trust income the trustee is taxed on any net income.
The trustee is generally taxed on the trust income at the highest marginal rate that applies to individuals except for some types of trusts (including deceased estates), which are taxed at modified individual rates.
The ATO and family trusts - what you need to know
The ATO is cracking down on family trusts.
What the ATO is cracking down on are a range of artificial schemes in which money washes to and from companies and also money that is paid to children, who promptly repay their parents for the cost of their upbringing.
There has been a lot of concern about the crackdown, with trust owners concerned that the ATO will start trawling back through time and apply penalties to any past behaviour also.
The ATO has denied it is on a fishing expedition but there is little doubt that it wants to crack down hard on a range of practices that have built up over the years.
A final word…
Family trusts can be a valuable tool, especially for families who want to share the financial fruits of their success.
However, it's vital that you access professional advice before considering whether family trusts will benefit your long-term wealth creation and protection goals.