What is a family trust?
To understand what a family trust is, it is useful to know what trusts are in general.
According to the Australian Taxation Office, a trust is an “obligation imposed on a person or other entity to hold property for the benefit of beneficiaries”.
In a trust, one party (the ‘trustee’) will hold the property on behalf of the other parties involved (the beneficiaries). These other parties are also entitled to benefits from the property.
In legal terms, a trust is considered to be a relationship rather than a legal entity. However, they are usually treated as taxpayer entities for tax administration purposes.
Family trusts are usually known as trusts that hold a family’s assets or run a family business. Generally, one or more family members (a trustee) will manage on behalf of the whole family (other beneficiaries). While the trustee is the legal owner of the property, there is an obligation to deal with the property in a way that benefits the beneficiaries.
A family trust is usually referred to as a “discretionary trust”. This means that the trustee has the authority to decide which beneficiary or beneficiaries receive the trust’s net income and capital gains each month.
Family trusts are commonly used to protect assets from bankruptcy or business failure. When the assets of the trust belong to the trustee instead of the beneficiaries, creditors of individual beneficiaries can not access assets.
These trusts can also protect family assets from potential marriage breakdowns. If there was a family law property settlement, assets in a family trust are more likely to be excluded from a property settlement.
Holding assets in a family trust can also prevent future challenges to Will. This is because assets held in the trust will not become part of a deceased estate, which can avoid a child's spouse claiming their share of the inheritance.
Protection for family members who may be vulnerable
A family trust can be a great way to protect vulnerable beneficiaries who struggle to make wise decisions with their money.
While they have access to a steady stream of income, they can not spend a large capital sum that is in the family trust.
In a family trust, trustees can give income and capital to any of the beneficiaries without restrictions.
- Any income earned by the trust that is not distributed is taxed at the top marginal tax rate
- There are punitive tax rates for distributions to children under 18 (66 percent)
- The trust cannot assign tax losses to beneficiaries
- To create and maintain a family trust, there are costs involved
- A family trust may be difficult to run if family disputes occur
Using a family trust for business
When utilised correctly, there are evident family trust benefits.
As the trust does not pay tax, beneficiaries are taxed by the amount of income allocated in their name but the trustee (in addition to their own income from other sources).
The trust creates a way to distribute profit to family members and use their income tax “tax-free thresholds”.
If the business’ profits grow to the point where the tax-free thresholds are surpassed, the family trust can distribute profits to a separate company. This will cap the tax rate at 27.5 percent.
While there are many benefits to using a family trust, entering into a family trust structure is more complicated than it seems. It’s important to carefully consider the pros and cons, and plan ahead for the future success of your business and/or assets.
If you are considering a family trust and want more information, contact Wagtail Wealth today.
IMPORTANT NOTE: This information is general advice only and does not take into account your personal circumstances, goals and objectives. Therefore, you should consider its appropriateness for your circumstances before acting on this information.