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Family Trusts Australia wide are hugely advantageous to the very wealthy due to the ability to split income and significantly reduce tax burden.
According to the Australian Bureau of Statistics only 3% of households owned family trusts in 2009-2010. In total, trust income in 2013–14 exceeded $340 billion.
Almost 50% of persons with a taxable income over $500,000 have some income from a trust.
Although not exactly an equitable situation, the government have so far failed to limit these advantages for the very wealthy. What sort of income is necessary before a trust worthwhile?
There are many types of trusts. In this article we will focus on “family” aka discretionary trusts Australia, and testamentary trusts.
What Are Family Trusts Australia?
A discretionary trust is not a legal entity, but a legally recognised relationship between trustee and beneficiary(s).
The trustee can be a person (usually a parent), a group of people (i.e. both parents) or a company (with parents as shareholders / directors).
Setting up a company involves extra costs, adds asset protection advantages and means in the event of death, a new company director can be appointed.
The trustee is responsible for the trust, liable for it’s debts and decides which beneficiaries trust income is distributed to. Trustees are legally required to act in the best interest of the beneficiaries and must be free from conflicts of interest.
The beneficiary receives income from the trust. There may be one or several beneficiaries, and with a discretionary trust the beneficiaries can change over the time.
Advantages of Family Trusts Australia
The most attractive feature of a family trust is the ability to split income between beneficiaries to minimize tax. It is therefore most advantageous when a family has several low-income persons (e.g. adult children, retired grandparents and non-working spouse).
The trust does not have to pay tax on income, unless it fails to distribute all income. However, undistributed income is taxed at 45%.
Beneficiaries pay tax at their own marginal rate. Children under 18 receiving non-employment income are taxed at penalty rates of 66%. Therefore, kids are not good beneficiaries until they are adults.
Assets sold from a trust retain the 50% capital gains discount eligibility they would benefit from outside a trust.
Asset protection is often a quoted benefit of a discretionary trust. If a beneficiary becomes bankrupt or financially troubled due to a legal case, any trust assets can be protected in some circumstances.
This protection is only valid if the assets have been inside the trust for a number of years before the financial/legal situation occurs. A discretionary trust is unlikely to provide any protection from your assets in the most likely financially devastating event, a divorce.
Disadvantages of Family Trusts Australia
Discretionary trusts can get pretty complicated, with corporate trustees, and lending strategies that can attract the unwanted attention of the ATO.
It is harder to borrow to buy property inside a trust, usually requiring loan to value rations of 60-70% as opposed to 80-90%.
Land tax is payable once you own over a state threshold in land value. Each state has it’s own threshold, and the threshold is for each individual or trust. So a family could own three properties in NSW with land value under the threshold of $734,000 without paying land tax, if one property was owned by mum, one by dad and one inside a trust. However, in Victoria, land tax is charged at a higher rated for properties purchased in a trust.
Family trusts incur set up and administration costs. I was quoted $600 for set up, $2000 annually for maintenance. There are firms online that will produce a DIY version for a fraction of this, but if everything is not correct may cost you far more. In order to save enough tax to compensate for these costs, assets in the trust probably need to value $300,000.
Any financial losses in the trust remain trapped inside the trust. They can be used to reduce tax on future financial gains within the trust, but cannot be used to negatively gear against employment income.
A discretionary trust has a lifespan of 80 years. Then, your children or grandchildren need to transfer the assets and pay capital gains tax.
Fixed, Hybrid and Bare trusts Australia
Fixed trusts define the beneficiaries’ predetermined income distribution percentage in the trust deeds. Hybrid trusts can combine some fixed distributions with some discretionary. A bare trust has only one beneficiary.
For Example: Family A – Single High Income
Mum earns $300,000
Dad stays at home earns $0
Children 16, 18, 20 all non-earning, studying
Mum’s marginal tax rate is 45%, dad’s is 0%, and they have 2 adult children who are currently on a 0% marginal rate
Option 1. Invest in dad’s name
Invest $300,000 in Australian shares – Yield 7% investment income $21000 + Franking credit refund
Buy $300,000 in International shares – Yield 4% investment income $12000.
Income will gradually increase if reinvested over time and reach the point at which dad will be taxed.
Dad could pay dividend income into superannuation to minimize taxable income
Will be protected from legal issues related to mum’s business if high risk
Mum has plenty of earnings! They want to invest long-term so lack of access to superannuation not an issue
Investment income taxed at 15% but will convert to long-term lump sum after retirement,
Using super is more advantageous the closer to preservation age you are, as you cannot pull this money out before you meet conditions of release.
Despite mum’s high income, dad is still eligible for the spouse contribution – Mum can claim 18% Tax offset for contributing $3000 to dad’s superannuation. Dad is not eligible for the low income super contribution unless he earns a little himself.
Superannuation is a type of trust, so offers asset protection
Option 3. Invest via a Trust
Will allow distribution of income to dad and adult children on low tax bracket – perfect for funding university studies. Once the eldest child is earning an income and on a higher tax bracket, the youngest child will turn 18 and become a beneficiary.
May be an option for parents many years from retirement who don’t wish to have money trapped in superannuation. This overcomes the issue of investment income exceeding dad’s tax-free threshold, but once the children are all working further beneficiaries will be required to minimize tax burden (eg retired grandparents). May also be useful for very few families who already contribute the maximum super concessional contributions ($100,000 per year, each!)
Also an option to own the business inside a trust of self-managed superfund for income streaming and asset protection. Trusts are less restricted by rules than a self managed super fund (SMSF).
Family B – Double Strong Incomes
Mum earns $150,000
Dad earns $150,000
Kids 16, 18, 20
Inheritance to invest 300,000
Option 1. Invest in mum/dad’s names
Mum and dad are both on the 37% tax bracket. Dividends will be taxed at this rate.
? Asset protection an issue for either – do they own a business?
Could consider using inheritance to pay down home mortgage, increasing equity. Then using equity to invest in a growth asset (eg negatively geared property) in the parent with the better income earning potential. There will be no tax payable until the property becomes positively geared. In the meantime, losses from investment income are offset against employment income of highest earner reducing PAYG tax burden. Lump sum is no longer accessible, but there may be cash flow freed up from mortgage pay off.
Option 2. Invest in superannuation
Pay $300,000 investment income into superannuation. Could put in lower income potential parent (using bring forward arrangements) or split between two. Will be inaccessible until preservation age and income taxed at 15% until rolled into a retirement account. Asset protection benefits of a trust apply.
Option 3. Invest in trust
Will allow income distribution to children whilst they are over 18 and earning low incomes. As the children earn better income, further beneficiaries will be required to minimise tax.
Variations of Discretionary Trust
Fixed trusts defines the beneficiaries’ predetermined income distribution percentage in the trust deeds. Hybrid trusts can combine some fixed distributions with some discretionary. A bare trust has only one beneficiary. Could split contribution between adults, or put in lower earning potential partners account to avoid hitting superannuation cap. Cannot access until preservation age, but this does support you in sticking to your long-term goals
For the Aussie Doc Family
I talked to my accountant about ownership of the next investment property.
There doesn’t seem to be much advantage for us right now over owning in Mr Aussie Doc’s name. Mr Aussie Doc also hits preservation age in less than 5 years, so superannuation is far more attractive to us.
We may reconsider at a later date (when the kids are closer to 18) but far prefer to keep things simple and low cost if possible.
Testamentary trusts Australia
Testamentary trusts are a common feature of wills, and could be far more appropriate for your situation.
These trusts only come into effect on the death of the benefactor (you!).
Different from discretionary trusts, there is no penalty tax for children under 18. They are entitled to an $18,200 tax free threshold similar to adults when receiving income through a testamentary trust. In the event of your untimely death whilst your children are dependents, the tax advantages can help make your superannuation, life insurance and other assets support your family for longer.
A discretionary testamentary trust allows income distribution to vary year to year, to maximise tax advantages, but will involve the trustee making these decisions. A fixed testamentary trust is probably simpler to manage but may not minimise tax as well every year. You can pay a professional to act as trustee, this will obviously involve fees but may help maintain family harmony.
A discretionary trust is also claimed to help protect your child’s inheritance from divorce, or if your partner remarries. It also allows some control over assets, if the child is likely to mismanage the assets.
A discretionary trust may be advantageous for family’s with businesses or significant assets outside superannuation, and multiple low-income beneficiaries. Many families could benefit from a testamentary trust as part of their will. The aim of the article is to give you an easier to understand summary of trusts. You must seek independent professional, and carefully chosen advice. Bare in mind that you starting a trust nenefits your accountant due to fees paid when considering this advice.
Aussie Doc Freedom is not a financial adviser and does need offer any advise. Information on this website is purely a description of my experiences and learning. Please check with your independent financial adviser or accountant before making any changes.See full terms and conditions in footer