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Is a family trust still a useful strategy?

There are pros and cons when it comes to trusts and you’ll need to accept
some risks on the way to collecting any benefits.

Family trusts are often in the headlines thanks to high profile family disputes or moves by regulators to limit their use as a tax minimisation tool. More recently, changes to superannuation have seen investors looking with renewed interest at family trust structures.

The number of discretionary trusts (many of them family trusts) has almost doubled over the last two decades. As of the 2014-15 financial year it stands at 643,000, which is a jump that’s far ahead of population growth1. And, along with their rising popularity have come increased media exposure and political debate.

Family trusts are generally considered the next most popular investment vehicle in Australia after superannuation. Which explains why, after the 2017 changes to super, there was anecdotal evidence of more clients asking their financial advisers about setting one up2.

The main reasons for setting up family trusts are income distribution flexibility (which may have tax benefits), asset protection and estate planning, says Peter O’Callaghan, Managing Partner at MSI Taylor Wealth Management. But he’s quick to point out that the decision to establish a trust needs to be based on your overall financial situation, family circumstances and stage of life.

More flexibility

Family trusts can be an effective means of reducing the rate of tax (income and capital gains) payable through the ability to split income between tax payers, even within the family.

O’Callaghan uses the example of his clients Diana*, on an annual salary of around $400,000, and her husband Marco*, who earns up to $90,000 per year. They have three children under seven years.

Diana had previously invested into a number of geared strategies to reduce tax but, as a result, she’d suffered financially during the global financial crisis. She wanted to save, but was looking for a safer approach, says O’Callaghan.

“So, we used a combination of investment gearing and regular savings, via a family trust structure, to manage the level of investment income and increase the potential pool of income recipients,” he says.

In their situation, establishing a family trust enables the couple to channel income from investments (and capital gains) to Marco when his income is lower, and use a corporate beneficiary when his marginal tax rate exceeds that of company tax rates. In addition, there is capacity to distribute up to $416 per annum to each child under the age of 18 (tax rates for children increase significantly above this threshold). As the children reach age 18, they’re taxed at adult marginal rates, and the ability to flexibly distribute income and capital gains increases.

The flexibility in income distribution allowed under a family trust is certainly an advantage, says Michelle Hartman, Partner at Deloitte Private.

“It’s particularly useful when kids are over 18 and not earning money themselves; you can help support them by making income distributions to them,” she says.

68-year-old Marg* is still working and has two adult children with disabilities, who are recipients of Centrelink pensions. Marg has accrued a large bank balance from an estimated surplus cashflow of more than $180,000 pa from wages, a superannuation pension, and investment income. She wants to be able to provide some support for the children without risking their Centrelink entitlements and is also concerned about how to pass her assets on to the children on her death.

Marg, who intends to continue working for another couple of years, is discussing with her accountant about gifting or loaning her savings to a family trust of which her children are two of a number of potential beneficiaries. If she were to be the trustee, she retains the discretion to manage the flow of income to optimise Centrelink payments. At the same time, Marg is considering asset purchases such as a house, that each of the children could ‘rent’ from the trust, securing their accommodation needs without the need for them to own the asset. Whether Marg ‘gifts’ or ‘loans’ the initial amount to the trust would be determined in consultation with her tax professional, says O’Callaghan.

Family trusts can be an effective means of reducing the rate of tax (income and capital gains) payable through the ability to split income between tax payers, even within the family.

Protecting assets

Holding assets in trusts can provide other benefits too, says Hartman. For example, if a couple has a number of assets, particularly properties, holding them all inside a trust means that when one partner dies the transfer of ownership of the assets is not required. The trustee continues to hold the assets for the benefit of the trust beneficiaries.

There’s also protection for assets, she says. “People at risk of being sued by creditors wouldn’t ordinarily own any assets personally.”

Estate planning

If you want to have influence beyond the grave over how your assets and income are used, a testamentary trust can be written into your Will. It has similar asset protection and tax advantages to a family trust.

One significant difference between family trusts and testamentary trusts is the tax treatment for income distributions received by beneficiaries who are under 18 years of age. Under a testamentary trust, children are taxed at the same rate as adults rather than the higher rates applied to distributions from a family trust. “Thus, a high-income earner with three small children could gain access to three additional adult tax-free thresholds by receiving an inheritance via a testamentary trust instead of directly. And, as trustee, the high-income earner would retain access to capital as well,” says O’Callaghan.

What are the risks?

Family trusts can provide many advantages but they’re not without risks. These include:

  • Paying top rate of tax if no distributions to nominated beneficiaries were minuted prior to 30 June.
  • The Trustee having a fallout with the Appointor and being removed.
  • A poorly drafted will that does not deal with replacement trustees. Furthermore, a trustee not appointing an Enduring Power of Attorney.
  • Legislative changes. For example the Australian Labor Party has promised to introduce a standard company tax rate for most family trust distributions to people over the age of 18.
  • The structure of the trust is important including the decision about who will play the various roles involved. For example, the ‘Appointor’, whose role is to appoint and remove the trustee, thereby has effective control of the trust’s assets. “If the trustee is making decisions the Appointor doesn’t like, they can remove the trustee and replace with a new trustee,” says Hartman.
  • If you have effective control of a trust, or are the source of a trust’s assets, even if the assets are intended for the benefit of someone else such as a child, your Centrelink entitlements may be affected.
  • Cost. The administration of a trust can be expensive and without a certain level of assets, it may not be a cost-effective strategy although in some cases it might still be useful.

Good advice is vital

It goes without saying that setting up a family trust relies on good advice. O’Callaghan says it’s usually an accountant or tax specialist who recommends the trust and helps lay the groundwork in establishing the structure. “Once the accountant says a trust structure is a good option, a financial adviser can then step in and discuss how to use the structure effectively taking into consideration the client’s situation, time horizon, needs and objectives. Our job as financial advisers is to aid clients to make informed decisions,” he says.

If your accountant has recommended a family trust, you can find a financial adviser here.

Disclaimer
Colonial First State Investments Limited ABN 98 002 348 352, AFS Licence 232468 (Colonial First State) is the issuer of super, pension and investment products. This document may include general advice but does not take into account your individual objectives, financial situation or needs. You should read the relevant Product Disclosure Statement (PDS) carefully and assess whether the information is appropriate for you and consider talking to a financial adviser before making an investment decision. A PDS for Colonial First State’s products are available at colonialfirststate.com.au or by calling us on 13 13 36.