by Leon Jones
A family trust can be a powerful tool for long-term wealth management, asset protection, and tax efficiency. However, it’s essential to understand both the benefits and potential pitfalls before diving in. Here’s a comprehensive guide to help you decide whether starting a family trust is right for you.
What is a Family Trust?
A family trust, also known as a discretionary trust, is set up to hold assets or conduct a family business, with the main purpose of benefiting the family group. It’s a way to manage assets, protect wealth, and provide for future generations while taking advantage of potential tax benefits.
Key Characteristics of a Family Trust:
- Asset Protection: Protects family assets from liabilities that may arise due to bankruptcy or legal claims against family members.
- Tax Efficiency: Distributes income to beneficiaries within the family group to take advantage of lower individual tax rates.
- Wealth Transfer: Provides a structured way to pass assets to future generations.
Setting Up a Family Trust
To set up a family trust, the following elements need to be in place:
- Trust Deed: This legal document outlines the rules of the trust, including how income and assets are managed and distributed.
- Settlor: The individual who establishes the trust by transferring an initial asset. The settlor generally has no further involvement with the trust.
- Trustee(s): Responsible for managing the trust’s assets according to the trust deed. Typically, this role is filled by family members or a company controlled by the family.
- Beneficiaries: The family members who benefit from the trust’s income and assets.
Pros and Cons of Family Trusts
While family trusts offer numerous advantages, they also come with certain risks and responsibilities. Below are some common mistakes to avoid:
- Trusts Have Expiry Dates
Family trusts do not last forever. Legislation restricts trusts to a maximum of 80 years, after which assets must be transferred, potentially triggering significant capital gains tax.
Tip: Be aware of these limits and plan for asset transfers well in advance.
- Overemphasis on Asset Protection
While protecting your assets is crucial, setting up a trust solely for asset protection may not always be the best strategy. Other protective measures, such as insurance, can often be more cost-effective.
Tip: Weigh the costs of setting up a trust against the level of protection you need.
- Personal Services Income (PSI)
If you earn income through personal services, such as consulting or freelancing, the ATO classifies it as PSI. This income cannot be distributed to others to lower your tax liability and will be taxed at your individual rate.
Tip: Consult an accountant to determine if your income qualifies as PSI before establishing a trust.
- Land Tax Implications
Properties held in a trust may attract higher land tax, especially in states like NSW, where there’s no tax-free threshold for trust-owned land.
Tip: Evaluate the impact of land tax on your investment returns before placing properties into a trust.
- Losses Cannot Be Distributed
Losses incurred within a trust cannot be distributed to beneficiaries, meaning they remain within the trust and cannot offset personal income or gains.
Tip: Be cautious when holding negatively geared properties in a trust, as you won’t benefit from personal tax relief on these losses.
- Ignoring the Trust Deed
The trust deed is the backbone of your family trust. If you don’t fully understand its contents, you might miss crucial provisions or limitations.
Tip: Regularly review your trust deed and consult with your advisor to ensure it aligns with your current circumstances.
- Distributions to Minors
Distributing income to minors can result in hefty penalty tax rates, with amounts over $416 taxed at rates as high as 68%.
Tip: Consider alternative ways to secure your children’s financial futures without incurring excessive taxes.
- Incorrect Trustee Appointment
Choosing individual trustees may expose them to personal liability. A corporate trustee, though more expensive, can provide better protection.
Tip: Evaluate the long-term benefits of appointing a corporate trustee.
- The Role of the Appointor
The appointor holds significant power within the trust, including the ability to replace trustees. This role should be clearly defined in the trust deed.
Tip: Consider carefully who will take on this role, as it can significantly impact the management of the trust.
- Using Standard Form Documents
Generic legal documents might not capture the unique needs of your family trust, potentially leading to inadequate legal protection or missed opportunities.
Tip: Invest in custom legal advice to ensure your trust deed is tailored to your specific requirements.
- Failing to Update Your Trust
Family dynamics and legal environments change. Births, deaths, marriages, and tax law changes all warrant a review of your trust’s terms.
Tip: Regularly update your trust deed to reflect current circumstances and maintain its effectiveness.
Is a Family Trust Right for You?
Family trusts can be incredibly beneficial but require careful planning and management. Before you proceed, consider your financial goals, family structure, and the potential costs. Consulting with a qualified financial adviser will help you weigh the pros and cons specific to your situation.
Next Steps
- Seek Advice: Always consult with financial, tax, and legal professionals before setting up a trust.
- Evaluate Your Needs: Consider whether a family trust aligns with your wealth management strategy.
- Stay Informed: Keep your trust deed up to date and stay informed of any legislative changes that may affect your trust.
If you’re considering starting a family trust and need guidance, we’re here to help. I’m a financial planner in Maitland, NSW helping clients in Newcastle and the Hunter Region. Let’s chat about how we can support your wealth-building journey.
Before acting on any information contained herein you should consider if it is suitable for you. You should also consider consulting a suitably qualified financial, tax and/or legal adviser. Information in this article is no substitute for professional financial advice. We encourage you to seek professional financial advice before making any investment or financial decisions. In any circumstance, before investing in any financial product you should obtain and read a Product Disclosure Statement and consider whether it is appropriate for your objectives, situation and needs.