Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 215

Heigh-ho heigh-ho, are family trusts the way to go?

An unintended consequence of the recent superannuation reforms is the increased interest in family trusts. This article looks at the principal benefits of family trusts, who might establish one, and some of the pitfalls to consider.

We’ll also take a clinical look at how Snow White might employ a family trust for the Seven Dwarfs … and of course, which of them lives happily ever after.

What are the benefits of a family trust?

The two most attractive benefits of a family trust are the discretion to split income to a wide range of potential beneficiaries and the extra level of asset protection. However, they are not suitable for everyone.

Who should consider a family trust?

In general, an employee with most of their wealth in super and any surplus cash flow directed to repaying the mortgage may find a family trust is not appropriate. Superannuation is already a concessionally-taxed investment vehicle. In addition, deductible interest expenses from investment loans are more tax effective for those on higher incomes than distributed to trust beneficiaries.

However, those who fall into the following categories may consider a family trust:

  1. Younger high-income earners who are generating surplus savings and need flexibility to access their capital.
  2. Individuals who are already maximising their $100,000 super contributions and require an alternative investment vehicle for their surplus cash flow.
  3. Superannuation members who have already reached their lifetime caps of $1.6 million.
  4. Those who seek superior asset protection from the family’s black sheep, avaricious and litigious ex-partners of the family members, or creditors of the family business.
  5. Higher income earners with a non-working spouse, children at university, or even the uninspired teenager who hasn’t quite decided on what to do with their life beyond becoming the ultimate Call of Duty warrior.
  6. Families with wealth who have low income beneficiaries, such as elderly parents.

[Register for our free weekly newsletter and receive our latest ebook, Cuffelinks Showcase]

A case study: Snow White and the Seven Dwarfs

Each dwarf manages his personal finances but will obligingly help one another out (they’re a tight-knit bunch). Collectively, they have done quite well accumulating wealth in superannuation and all profits from the mines have been shared equally. Along comes Snow White, who suggests a family trust to help the dwarfs manage their family wealth in the most tax-effective way. She reviews each dwarf’s circumstances and suggests the following strategies:

Doc likes to think he’s the unofficial head of the household. He is a health practitioner and the main bread-winner on the highest marginal tax rate. Doc would have little or no income distributions from the family trust given that it is not tax-effective to do so.

Grumpy doesn’t like to work with anyone and runs a successful small business making and selling mining equipment to the other dwarfs. Grumpy transfers the business into the family trust, ensuring that dividends from his company are franked prior to distributing income to himself.

Happy has recently completed a degree in gemmology, is now studying for a Masters in Mineral Sciences and works part-time in the mines. He believes that money can buy happiness and frequently buys extravagant collectors’ items online. Whilst he is studying and working, Snow White suggests that some income distributions be sent his way to even out the overall taxable income of the other lower-income beneficiaries.

Sneezy was made redundant this financial year and has only been able to find the odd casual job due to his sinus-related maladies. Because he has received a significant taxable termination payment, Snow White advises that income distributions would be best considered in the following financial year.

Bashful doesn’t like to share much about his personal finances but has been extremely successful in the mines. He’s amassed a small fortune and quietly lives off his abundant dividends. Snow White suggests that he loan the capital to the family trust and continue to draw his modest income needs from the trust. Future investment gains realised from his contributed capital can be distributed to his dwarf brethren to reduce CGT.

Sleepy is a lazy teenager and has little aspiration to study or seek a full-time job. Snow suggests that Sleepy should receive a higher distribution of income to fully utilise his tax-free threshold and low-income tax offset.

Dopey is much loved but incredibly naïve and dull-witted. Snow recommends that his wealth be transferred into the family trust to protect him from trading his wealth to the Wicked Queen for a shiny red apple.

Pitfalls to consider

Individuals on government income support should be mindful that any involvement with family trusts may affect their entitlements, as being a trustee or beneficiary may be assessed as owning all or some of the trust assets. Income distributions are also captured as assessable income and could have an adverse impact on Centrelink benefits.

Any income loss generated by assets owned by a trust are trapped in the trust and hence cannot be distributed to beneficiaries to reduce their personal taxable income. This is usually carried forward and applied against future income of the trust (such as a capital gains event). Therefore, if borrowing for investment purposes may be better gearing in an individual’s name to maximise negative gearing benefits to the highest-taxed income earner. However, the discretion to distribute any future capital gains is lost.

Whilst a family trust is a good investment structure which allows intergenerational wealth transfer without capital gains or stamp duty, it is generally considered a terrible idea to transfer your existing family home into a trust as the transfer would be considered a CGT event and the main residence exemption would be lost.

Consider what will happen to the trust in the event of a death. The trust assets do not form part of an estate and cannot be given away under the terms of a will. The only ‘asset’ which trustees can leave in respect of the family trust is their ability to pass control of that trust to the executor of their estate or their children.

Although the assets owned by the family trust do not form part of your estate, if the investment capital was a loan to the trust, this is considered as an asset of the estate. That is, the family trust may need to repay the loaned capital if called upon by the will. Therefore, it would be prudent to review wills to ensure that a death does not create a sudden need for the family trust to sell assets in order to repay the loan to the estate.

On relationship breakdown, one spouse may argue that the assets in the family trust do not form part of the pool of assets to consider at separation. This is often contested in the Family Courts.

As for Ms. White and the diverse band of dwarfs …

Ultimately, through the family trust, Snow White was able to help the seven dwarfs create a structure which provided certainty and a measure of security around their mining empire. The family wealth was protected from spendthrift and vulnerable individuals, and a platform was created for tax minimisation that can be passed onto future generations.

As a sign of their undying gratitude for Snow White’s guidance, the dwarfs successfully lobbied the ATO to audit the financial records of the Evil Queen’s apple orchard, which then went bust and was re-purchased in an (arm’s length) fire-sale by Snow White and her new beau, a handsome young prince. Snow White was last seen brainstorming plans for the orchard’s transformation into a cider manufacturer.

 

Diana Chan is Head of Compliance at financial advisers, Stanford Brown. This article is general information and does not consider the circumstances of any individual (except Snow White). This complex issue should be discussed with a qualified financial adviser or tax consultant to determine whether it is in anyone’s best interests.

In a foreword to The Hobbit, published in 1937, J R R Tolkien writes: "In English, the only correct plural of 'dwarf' is 'dwarfs' and the adjective is 'dwarfish'. 'Dwarves' and 'dwarvish' are used only when speaking of the ancient people to whom Thorin Oakenshield and his companions belonged."

4 Comments
Geoff
August 18, 2017

Regardless of so called asset protection, which is only real in some cases, the ability for some taxpayers to minimise tax by splitting income between diverse family members, whilst others are caught for unavoidable tax on salaries and wages, is exactly why the ALP wants to tax discretionary trusts. It is inequitable!

Jack
August 18, 2017

The interaction between family trusts and Centrelink payments is not well understood. As Centrelink pensions depend on the assets test, many people used to maximize their pension payments by hiding assets in a family trust. In that case they no longer owned the assets and therefore the assets test did not reduce their pension.

All that changed in 2002. Legislation was enacted so that a Centrelink recipient who was also a beneficiary of a trust would be assessed as owning ALL the assets in the trust. Two tests are applied. An attribution test - the assets in the trust can be attributed to the Centrelink claimant and a control test - the test is still effectively controlled by the Centrelink claimant.

Since 2002, family trusts can not be used to circumvent the assets test for Centrelink purposes. This applies to both the age pension and the disability support pension.

JZ
August 17, 2017

Great article and well covering of the issues. I am a bit concerned that SW has enabled Sleepy's behaviour leading to future problems...

Robin
August 17, 2017

Diana's advice regarding prudent decision making regarding income distributions to beneficiaries on government income support can often be overlooked by trustees, appointors and accountants. It is worth noting that an income distribution for a beneficiary on a government income support payment is assessed as income for 52 weeks from the date of legal entitlement, rather than the period the trust derives the income. The trustee resolution minute wording, structure and date will dictate when the date of legal entitllement will be commence in accordance with section 1073 of the Social Security Act. Also be mindful that a beneficiary loan is a deemed financial asset included in the income and assets test for determining a government income support entitllement.

 

Leave a Comment:

     
banner

Most viewed in recent weeks

Three steps to planning your spending in retirement

What happens when a superannuation expert sets up his own retirement portfolio using decades of knowledge? He finds he can afford much more investment risk in his portfolio than conventional thinking suggests.

Five stock recoveries not hanging on COVID predictions

The focus on predicting the recovery from the pandemic is the wrong emphasis. Better to identify great companies benefitting from market changes over a three- to five-year horizon with or without COVID.

Peak to peak, which LIC managers performed during COVID?

A comprehensive review of dozens of LICs shows how they performed in the crucial 'peak to peak' of COVID. This 14 months tested the mettle and strategies of a sector often under fire, with many strong results.

Finding sustainable dividend stocks on the ASX

There is a small universe of companies on the ASX which are reliable dividend payers over five years, are fairly valued and are classified as ‘negligible’ or ‘low’ on both ESG risk and carbon risk.

Blink and you missed a seismic shift in these stocks

Blink and it happened. If announcements in this sector were made by a producer of iron ore, gas, copper or some new tech, the news would have been splashed across the front pages. Have we witnessed a major change?

How inflation impacts different types of investments

A comprehensive study of the impact of inflation on returns from different assets over the past 120 years. The high returns in recent years are due to low inflation and falling rates but this ‘sweet spot’ is ending.

Latest Updates

Shares

Platinum’s four guiding investment principles

Buying mispriced stocks is often uncomfortable when companies are outside the spotlight and markets are driven by emotions. And it's inescapable that the price paid ultimately determines the end result.

Interviews

Andrew Lockhart on corporate loans as an income alternative

Loans to corporates were the traditional domain of banks, but as investors look for income alternatives to term deposits, funds have combined hundreds of loans into a single structure to create a diversified investment.

Retirement

10 things I learned in my faux-retirement

Pre-retirees should ‘trial run’ their retirements. All those things you want to do - play golf, time with the family, a hobby, write a book - might not be so appealing in reality, but you might discover other benefits.

Retirement

Achieving a sufficient retirement income portfolio

Retirees require a reliable income stream to replace the wages they received when they were working and should focus on the dollar income generated over time rather than the headline yield percentage.

'Wealth of Experience' podcast and ASA webinar on ETFs v LICs

Peter reveals some top stock picks with an emphasis on long-term assets like Sydney Airport, Graham discusses spending in retirement and valuing assets, the key to Amazon, guest Andrew Lockhart and plenty more.

Strategy

Lucy Turnbull’s three lessons on leadership and successful careers

From promoting women to boost culture to taking opportunities as they arise, Lucy Turnbull AO says markets should not drive decision-making and leaders must live and breathe the company's mission and values.

Economy

Are concerns about inflation inflated?

While REITs and some value stocks are considered 'inflation-sensitive' assets, the data provide little support that they are good inflation hedges, and energy stocks and commodities are too volatile. So what works?

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.