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What are the advantages and disadvantages of family trusts?

Most people tend to follow a pattern in life. They go to school, obtain qualifications, get a job, pay taxes, and eventually settle down with a family. During this time, many make investments and even start a business to increase their wealth and assets.

They can either own those wealth and assets in their own name or set an alternative structure like a family trust to hold them. Such a structure could assist with tax planning, asset protection and obtaining tax benefits.

This article discusses the advantages and disadvantages of family trusts.

What are family trusts?

A family trust is a discretionary trust that is used in Australia to hold the wealth and assets of a family. It is also commonly used as the structure for family businesses.

A trust is a legal structure under which a person (the trustee) holds the legal title of a property for the benefit of other people (the beneficiaries). The trustee has a wide range of powers to deal with the property, and any profits generated from that property are distributed to the beneficiaries.

A discretionary trust is a type of trust structure. The most distinguishing feature is that the trustee has the discretion on how much to distribute to each beneficiary if any money is distributed. The beneficiaries are not guaranteed to be paid, they just have an expectation of being paid.

In family trusts, the beneficiaries are usually members of the same family, and a person from the family or a company controlled by the family will be the trustee. This trustee has broad discretion including on the distribution of the income from the trust. 

Let us look at some of the advantages and disadvantages of a family trust.

Advantages of family trusts

1. Tax planning

A family trust is taxed at the highest income tax rate, which is 45%. However, any trust income distributed to the beneficiaries is taxed at the income tax rate of the beneficiary who receives the distribution.

A family trust is commonly used to minimise the total income tax paid by the whole family. Generally, the trustee in a family trust distributes the trust income among the trust’s beneficiaries and allocates more distribution for a family member with a lower income tax rate than the other parties. This reduces the total amount of tax paid on the trust income by the beneficiaries.

2. Asset protection

A family trust structure can protect your family’s wealth from creditors. Usually, when a person owes money and cannot meet the repayment requirements, the creditor can access the person’s personal asset to recoup the debt payable. Personal assets include your home, car, and other property a person owns in their name. If the family trust is holding the personal assets, then the trust’s beneficiary has no legal rights over those personal properties and creditors of the beneficiaries cannot access them. This includes even if a beneficiary becomes bankrupt.

3. 50% capital gains tax discount

A capital gains tax is payable on any profits from the sale of an asset. A family trust receives a 50% discount on capital gains tax for profits made from selling any assets the trust has held for more than 12 months.

4. Carry forward losses

A trust does not distribute losses to beneficiaries. This means the beneficiaries will not be called upon to contribute money to the trust to meet any loss. Instead, losses from each year can be carried forward to the following year.

Disadvantages of family trusts

1. Grow as a business

A family trust is also used as the business structure for family businesses. While this structure offers benefits like those outlined above, it restrains a business’s ability to grow. Due to the high tax applied to trust income that is not distributed, trustees almost always distribute the income. Therefore, the business cannot retain the profits to reinvest in the business for the following years. Lenders such as banks are reluctant to lend to trust structures when compared to other business structures like a company.

2. Family disputes

It is usual for families to have disputes. Disputes about the control of the trust can occur where the trust holds a significant amount of family wealth. If the trust deed does not clearly set out the procedure to appoint or replace a trustee and how trust income should be distributed, then family disputes are more likely to occur. To avoid such disputes, the trust deed must set out clear procedures.

3. Liability of the trustee

A family trust provides excellent protection for beneficiaries both from an asset protection and tax planning perspective. However, a trustee is legally liable for the obligations of the trust, including any debts it owes. This can cause significant personal risk to the trustee if the trustee is an individual, which is why a company is often used as the trustee.

Should you set a family trust?

The merit of a family trust depends on your personal circumstances. You will need to get independent legal and financial advice to determine if a family trust structure could benefit you and your family. Note that transferring existing assets to a family trust will come with tax implications.

 

Stebin Sam is a practising commercial solicitor at LegalVision and a freelance content writer. LegalVision can be contacted on 1300 544 755 or their membership page. If you need help with setting up a family trust, LegalVision’s experienced corporate lawyers can assist as part of its membership offering.

Disclaimer: The above article is for information purposes only and does not constitute a specific product recommendation, or taxation or financial advice and should not be relied upon as such. While we use reasonable endeavours to keep the information up-to-date, we make no representation that any information is accurate or up-to-date. If you choose to make use of the content in this article, you do so at your own risk. To the extent permitted by law, we do not assume any responsibility or liability arising from or connected with your use or reliance on the content on our site. Please check with your adviser or accountant to obtain the correct advice for your situation.

 

11 Comments
AndrewB
February 15, 2022

Disadvantage: If a trust has a loss for the year and has received franked dividends, the franking credits are lost. An individual receives a refund of them, and a company can convert them into additional losses, but they are lost in a discretionary trust.

Billy Don’t Be A Hero
February 13, 2022

Missed many points listed above already. If trust incurs tax loss, the loss is retained in trust can’t be used by beneficiaries to offset against their other taxable income. Tax loss retained by trust until offset by future trust taxable income. Also complete codswallop that lenders don’t like lending to trusts. Lenders will lend to anyone after considering their ability to service debt and provide security. Lenders will make sure that their security documents reflect this. What is missed is that Labor would like to tax trusts like companies and who has the ultimate power over the trust - the ability to hire and fire trustees- the appointor.

Collin Vost
February 12, 2022

What if the initial set up Funds are loaned to the Trust and the lenders suffer a financial collapse...............can the investors/Lenders creditors wind up the trust to get the assets

What is the preferable way to set up a Funds funding ................ by loans........ or by Gifts ??

Are the Gifts taxable to the Investor/Lenders ??

Providing beneficiaries agreed a Trust running a business could re invest the distributions to beneficiaries after tax to the Trust ..........hence previous questions??

Donal Griffin
February 11, 2022

There is also an underappreciated understanding of the challenges in handing on control of such a trust to the next generation. Those people view those trusts as unit trusts even though they are not entitled to a specific share. They are very disappointed to find that good succession of a discretionary trust, without good advice, relies on goodwill and goodluck!

AlanB
February 11, 2022

I have share investments split between a family trust and a SMSF. I prefer the trust because it is easier to manage with fewer ever changing regulatory requirements than the SMSF. The trust costs less in accounting and auditing fees compared to the SMSF. The trust however proportionately pays more in tax. My plan is to eventually wind up the administratively tedious SmsF and distribute its funds to beneficiaries or back into the family trust.

Graham W
February 10, 2022

Another disadvantage of family trusts (and also of family companies) is when a beneficiary of the trust ( or as a company shareholder) is seeking Centrelink benefits. Although they may not have a legal claim to the assets held by either entity they can still be deemed to be holding that value as part of their assessable assets. This is by a process that Centrelink calls Attribution and it is one in which they hold all the cards and it is very hard to contest. It is a see through provision, that effectively ignores the lack of legal entitlement of the Centrelink applicant.
In the case of marital breakdowns similar provisions apply to allow assets in family trusts and family companies to be considered as splittable.

Steven
February 10, 2022

One further possible disadvantage of trusts that hold property is paying the 1.6% additional land tax (if in NSW).

Peter
March 03, 2022

Yes, Land Tax can represent a huge slice (say about 45%) out of gross rental income of a single held trust asset like a Residential Property Investment. I.e, the trust hold no other major assets.

So this aspect may be extremely important when considering your total overall tax position.

Some may agree that it may be a little bit unfair on a family that has the wife working in basic wage employment and the husband retired (non-centre link pension eligible.)

Sam
February 10, 2022

How is a family trust viewed in the eyes of divorce proceedings? Can this also be a form of protecting assets from the risk of marital breakdown?

Jon Kalkman
February 10, 2022

It is disappointing that this article did not mention one of the most important attributes of a trust and that is: Because you do not “own” the assets held in a trust, they are not part of your estate and not subject to your will. On your death, the trust assets remain under the control of the trustee and your death has no effect on a family trust or it’s assets unless you are the trustee, in which case you need a succession plan.

That has particular relevance to superannuation because a super fund is a special kind of trust, and for a SMSF, trustee succession planning is critical.

Trevor
February 10, 2022

Thanks for that clarification, Jon Kalkman: " ... you do not “own” the assets held in a trust, they are not part of your estate and not subject to your will." "On your death, the trust assets remain under the control of the trustee and your death has no effect on a family trust or it’s assets unless you are the trustee, in which case you need a succession plan."

 

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