Establishing a Family Trust?

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Establishing a family trust is a very popular choice of investment structure among my clients. This is due to the tax minimisation and asset protection benefits available as well as a family trust’s succession and estate planning qualities.

However, as with all things, the qualities of a family trust may only be realised when it’s structured properly and implemented appropriately. In assessing what is appropriate for any given set of circumstances, provided below is an overview of the factors to consider when making your choice to establish and maintain a family trust.

What is a Family Trust?

A family trust is not a legal entity in itself, it’s merely the trustee holding assets for the benefit of others as governed by the trust’s deed. It’s a relationship between the trustee and the beneficiaries of the trust.

The trustee will legally own the assets of your family trust and it’s the trustee who is responsible for the management duties. In this respect, the trustee must act according to the terms as set out in trust deed.

The beneficiaries of a family trust are usually those family members, private investment companies, or even other trusts that are either explicitly named as a beneficiary or are eligible to belong to a class of beneficiaries as prescribed by the trust deed. In establishing your trust, you have the flexibility of determining who may qualify as a potential beneficiary, which can serve as an important decision should your family circumstances change.

Typically, the appointor is the ultimate controller of a family trust and is arguably the most important role to consider. It’s the appointor’s role to select who acts as trustee. You may have multiple appointors and replacement appointors, as relevant for your estate planning considerations.

A settlor will be the originator of your family trust and is the role usually played by your financial adviser or the legal services firm who prepares your trust documents. In current times, the settlor is also often played by a ‘nearest and dearest’ of the client. Generally, the settlor “settles” on trust a nominal sum of capital to bring the family trust into existence. Apart from that act, the settlor does not play any further role in your trust.

Taxation Benefits

Income Splitting
“Income splitting” is commonly heralded as the key tax benefit of utilising a family trust. It’s the ability of the trustee to distribute your family trust’s income to beneficiaries in different proportions each year. In doing so, and with a degree of tax planning, the trustee has the potential to minimise the overall tax paid on the trust’s income.

For example, for any given year the trustee may choose to distribute your family trust’s income to your family members who incur the lowest marginal income tax rates. Or alternatively, the trustee may decide to distribute the trust’s income to your private investment company, thereby capping the tax paid on that income to the company tax rate. The trustee may also choose to use a combination of these approaches each year.

Income Streaming
To further assist in minimising the overall tax paid on your family trust’s income is the ability of the trustee to “income stream”. It refers to the ability of the trustee, each year, to specifically entitle certain beneficiaries to the trust’s franked dividends and capital gains, to the exclusion of others.

Income streaming is of particular benefit when considering the capital gains tax discount which is available to individual beneficiaries, and when considering which beneficiaries may be entitled to a tax refund for the imputation credits attached to any franked dividends they receive.

Importantly, the trustee must always bear in mind that should the income of the trust not be distributed for a given income year, the trustee itself may be subject to penalty tax. Further, by creating an entitlement of a beneficiary in the trust by way of a distribution of income, the trustee creates a legal debt that is recoverable by that beneficiary as against the trustee.

Asset Protection
A properly structured family trust should protect the trust’s assets from a range of different risks, such as bankruptcy, business failure and other legal actions.

Importantly, because the trustee is the legal owner of the trust’s assets, any claim made against a beneficiary in their individual capacity should generally not result in recourse against the family trust’s assets. That is, provided that any trust entitlements of that beneficiary has already been satisfied or otherwise extinguished.

When it comes to asset protection, because of the significance of the legal separation between the trustee and the beneficiaries of the trust, a corporate trustee is generally recommended to act as trustee. This is usually a specifically incorporated company whose only purpose is to be the legal owner of the trust assets.

A corporate trustee protects against the potential co-mingling of trust and personal assets and even the assets of your self-managed superannuation fund. Keeping trust asset ownership distinct from these other assets assists in protecting the trust’s assets from unnecessary risks.

Succession and Estate Planning
The assets held by a family trust will not form part of your personal estate and must be considered separately when managing your succession and estate plan.

Rather than via your will and last testament, and other than by way of debt interests in the trust estate, the transfer of your trust’s wealth to the next generation can be achieved by changing who controls your trust. The question is essentially who is going to be the new appointor of your family trust going forward.

A new appointor can be facilitated by a surviving joint appointor or a successor appointor clause in your family trust deed. The appointor role can be a single person or multiple people, for example, it may be you and your spouse and thereafter your children who mutually act as appointors.

Alternatively, a private company can also act as the appointor of your family trust. The succession plan in respect of the appointor role is then managed via the shareholdings of that private company, which can be achieved through your will.

However, if there is no explicit mechanism for the succession of the appointor role of your family trust, that role may instead pass to your executor, or it is the executor who has the power to choose the new appointor as expressed by the wishes in your will.

Using a corporate trustee, as opposed to individual trustees, will also facilitate the change of control of your family trust. Instead of the new appointor of your trust choosing to install a new trustee, thereby requiring the burdensome task of updating the legal titles of all trust assets, the change of trustee can instead be simply managed via the shareholders of the corporate trustee. This again can be achieved via your will.

It is clear to see why a family trust is an attractive investment structure. It is also equally clear that due consideration must be given to the above factors for the overall benefits of a family trust to be realised.

About the Author

Dean Crossingham

Dean is an Accountant and Tax Adviser who provides expert tax compliance and specialised tax advice services to eminent and entrepreneurial executives, families and private businesses.

Dean Crossingham