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A family trust is an agreement where a person or a company agrees to hold assets for others’ benefit, usually their family members. It is often set up by families to own assets. A family trust is also known as a discretionary trust. The reason for this name refers to the trustee’s discretionary powers to decide which beneficiary or beneficiaries receive the trust’s net income and capital gains each year. Likewise, the trustee can also decide how much income each beneficiary receives. This is in contrast to a fixed or unit trust where the distribution of the trust income and capital gains are fixed. This article will explain the key aspects of a family trust, and the advantages and disadvantages of using one.

The Trust Deed

Unlike a company, a trust is not a separate legal entity. Instead, it is an agreement between the key parties to the trust. This agreement between the parties needs to be written down in the form of a trust deed. The trust deed is the legal agreement that will govern the operation of the trust and the role of each party to the trust.

Key Parties to a Family Trust

Trustee

A trustee is a person or company who is listed as the legal owner of the trust’s assets. The trustee is solely responsible for the trust and the trust’s creditors. When the trustee of a trust is a person, that person may be legally responsible to creditors of the trust. However, if the trustee is a company, the company is legally responsible to any creditors. Therefore, a company is often nominated or set up as the trustee of a trust to eliminate a trustee’s personal legal responsibility to creditors. You can appoint more than one party as the trustee of your trust.

For example, you borrow money from the bank for a house that is owned by a trust. Say you buy it for $1,000,000 and then sell it for $600,000. The bank will want its $1,000,000 back, but you only have $600,000. The bank can go after the trustee for the remaining $400,000. If you are an individual trustee, then the bank can take your car or other assets to satisfy the debt. This is because you are personally liable to the bank (your creditor). However, if you have a corporate trustee and that company has no money or assets, the bank will not be able to retrieve the $400,000 from the trust.

The trustee of a trust also has the authority to distribute any income and capital gains of the trust to the nominated beneficiaries, at its absolute discretion.

Beneficiaries

A beneficiary or beneficiaries of a trust are the people or companies who may benefit from the trust. They gain entitlements to receive the trust’s income and capital gains if the trustee nominates them in a given financial year. Unlike the trustee, beneficiaries do not have control of the trust.

You can name the primary beneficiaries of your trust and also nominate unnamed beneficiaries. These unnamed beneficiaries can include the extended family of the named primary beneficiaries.

For example, the trustee can nominate for “the spouse of Brian Hunter” (your unnamed primary beneficiary) to be entitled to receive the trust income in the trust deed.

Settlor

The settlor only has a role in the setup stage of the trust. To form a family trust, a settlor needs to give assets or a sum of money to the trustee and sign the trust deed. Once the trust has been set up, the settlor will have no ongoing involvement in the trust.

For tax reasons, the settlor should be someone with no other connection to the trust. Often, a family friend, lawyer or accountant is nominated to act as the settlor of a trust.

Appointer

Often, the appointer of a family trust is the person who wants to set up the trust. The appointer is also responsible for appointing and replacing the trustee or trustees of the trust. As such, they have the ultimate control of the trust’s assets. However, the appointer is not involved in the day-to-day control and running of the trust. Rather, the trustee fills this role.

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Advantages of a Family Trust

Flexibility in Distributing Income and Capital Gains

The trustee of a trust has absolute discretion when it comes to distributing the trust’s net income and capital gains to the beneficiaries of the trust. This means they can choose to distribute whatever they want to whomever they want. This may translate into tax advantages.

For example, you distribute your taxable income to your children through a trust. Now, instead of being taxed for that income at your personal marginal tax rate of 45% (excluding levies), the income is taxed at your children’s lower marginal tax rates. However, note that this only applies if your children are over 18 years old. Trust distributions to minors are taxed at a rate of up to 66%. The same goes for distributions of capital gains through trust.

Notably, capital losses cannot be distributed to trust beneficiaries. Instead, they can be carried forward to offset the trust’s capital gains in the next financial year. This works to reduce the trust’s net income.

Asset Protection

A family trust also offers some degree of protection for your personal assets. In most cases, a creditor cannot take a trustee’s personal assets in the event of bankruptcy. Likewise, creditors cannot take assets held by a company trustee in the event of that company’s liquidation, subject to some exceptions.

Low Set-Up Costs

The trust deed governs the life of a family trust. However, a family trust has a maximum life of 80 years, except in South Australia where the maximum is unlimited. Relative to its life, the costs of setting up a trust is relatively low. Unlike setting up a company where you have to pay the Australian Securities and Commission (ASIC) a fee each year, there are no ongoing government fees attached to a trust.

Disadvantages of a Family Trust

Not Suitable for Running Businesses

There are several reasons why it is uncommon to run a business through a family trust. Firstly, the trustee will need to distribute any income the business makes to the beneficiaries. Consequently, the business itself cannot retain any profits. Likewise, the trustee of a trust must legally pay tax on any undistributed income of the trust at the highest marginal tax rate.

Secondly, the trustee of a trust may be personally liable for the debts of the business. Remember, a trust is not a separate legal entity (like a company is), but rather an agreement between the parties of the trust. However, you can eliminate this risk by nominating a company to act as the trustee of your trust.

Loss of Ownership of Assets

Remember that the trustee of your trust will hold the legal title over the trust’s assets. This means that when you establish your trust, you will need to transfer your ownership over the assets to the trustee. Often, this transaction will give rise to Capital Gains Tax (CGT). It may also give rise to stamp duty and Goods and Services Tax (GST).

Ongoing Management

Once you have set up a trust, you will need to consider the time and cost involved in meeting the trust’s annual accounting and administrative requirements. Often people hire an accountant to do this for them.

Common Uses of a Family Trust

Families often set up a trust to hold assets, for example, physical property or shares in a company.

For example, if you own a business that you run as a company, you may choose to hold your shares in the company through a trust. This allows you to safely hold your shares from creditors and to distribute your dividends to your family members for more favourable tax outcomes.

You can hold more than one asset in a family trust. Often, people have one family trust whereby they store all or most of their assets for distribution. This acts a bit like a “family bank”.

Key Takeaways

Families often set up a family trust to hold both their physical and non-physical assets. The main benefits of having a family trust are the tax benefits and the flexibility it provides in distributing income to family members. Before you form a family trust, it is important to understand the key players in a trust and to have someone in mind for each role. A trust deed governs your family trust and how it works. It is therefore crucial that you have it drafted the way you want your trust to work. Importantly, if you make changes to the trust deed after setting up your trust, it may give rise to tax implications.

If you have questions about setting up a family trust, get in touch with LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.

Frequently Asked Questions

Why choose a family trust?

A family trust is an agreement where a person or a company agrees to hold assets for others’ benefit, usually their family members. Notably, a family trust, otherwise known as a discretionary trust, is a great way to manage and protect family assets. For example, the trustee may manage the trust’s assets for specific children (beneficiaries) until they turn 18.

Who are the key parties to a trust?

The key parties to a trust include the settlor, trustee, appointer and the beneficiaries. The settlor is an individual whose role is to place the property into the trust. This is known as a settlement or gift. The trustee is the legal owner of the trust’s assets and is in charge of distributing and managing those assets as per the trust deed. Likewise, the appointer can appoint and remove trustees under the trust deed. Finally, beneficiaries are individuals listed in the trust deed who have entitlements to the trust’s income.

Why should I set up a family trust?

A family trust is a great way to hold assets, such as physical property or shares in a company. This is because it allows you to safely hold your assets from creditors and to distribute your dividends to your family members for more favourable tax outcomes.

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