Why You Should Set Up a Family Trust
Published 3:56 am 29 Apr 2021
What is a trust and what is a company?
A trust is a private arrangement created by a person to meet specific needs. It’s terms and conditions are contained in a tailor-made specially crafted document called a ‘deed of trust’. The deed of trust sets out the purpose of the trust, its terms and conditions, what it can and can’t do and who the beneficiaries are to be. The deed of trust being a private document does not have to be registered with any government department and its content is secret so that it is not open to public inspection and examination.
A company is a public government-controlled entity. Legislation, usually called the Companies Act or the Corporations Act or similar, sets out rules and regulations in standard form for the operation, management and function of the company. The rules and regulations or powers of the company are contained in its constitution. The two main types of company are a public company and a proprietary or private company. A public company is one that is listed on the stock exchange where its’ shares are traded, bought and sold by other companies and individuals. A proprietary private company is one that is not listed on the stock exchange and its shares are not available for public trading. Anyone can search a company’s records held by governments, in the case of public companies their financial records are open to view but in the case of proprietary companies, their financial records don’t usually have to be disclosed at all.
Because a trust deed is not registered anywhere and is not open for public scrutiny, the trust’s affairs and particularly its finances are private. The exception being that the trust may need to lodge income tax returns.
What is the structure of a trust deed?
A trust starts off and is created by an independent and associated person who is called “the settlor’. This person provides some money to the trust called “the settled sum” which is deposited into the trust bank account. There are no rules as to the amount of money required, it can be $10, $100 or anything else, but when the settlor provides the money and signs the deed of trust, his or her role in the transaction is finalised and that person plays no further part in the trust. The trust deed will also specify a person who will be the trustee of the trust. The trustee is independent of the trusts affairs and the role is one of management and control. There can be several individuals named as trustees and a proprietary company can be a trustee on its own or in conjunction with one or more individuals. The third and final participant the creation of the trust is an appointor. This person or company is a general overseer of the trust’s operations, ranking above the role of the trustee. In short, the appointor can hire and fire trustees.
What can a trust do?
The things the family trust can do, or its legal powers, are contained in the deed of trust. For example a trust can own real estate, can lend money, borrow money, trade shares on the stock exchange, buy a business and broadly, conduct all kinds of financial activities. If the trust wants to do something and the power to do so isn’t set out in the family trust deed, then it is easy for the trustee to amend the deed of trust so as to enable the activity to be legally undertaken.
Who are the beneficiaries of a trust?
There must be beneficiaries of the trust because setting up a trust that isn’t for the benefit of anyone is not a trust at all. In the case of a family trust the beneficiaries will usually be the parents, children and grandchildren, but the list of people who can be included or excluded from time to time is at the sole discretion of the trustee.
What is a discretionary trust?
A discretionary family trust is an ordinary basic kind of trust where the trustee has the power to act in the best interests of the trust and the beneficiaries. Within the boundaries of legal behaviour, the trustee has the discretion to do what is thought best. More importantly, the trustee has the discretion of choice as to the distribution of the profits of the trust. The trustee has the ability to decide when to make a distribution to beneficiaries, in what amounts and to whom. The beneficiaries’ entitlement requires those named in the of deed of family trust be named in the list beneficiaries in the trust deed. That is, a beneficiary qualifies for entitlement by being named however, the trustee is the one who decides whether to pay anything to any of the beneficiaries at a particular time. So, it is the trustee who decides the amounts, if any, to be distributed to beneficiaries and those amounts don’t have to be equal. Beneficiaries who are named in the list but don’t receive a distribution have no legal grounds to make any complaint against the trustee.
What are the benefits of a family trust?
The two popular benefits are that (a) the family members don’t own anything in their names and (b) income splitting is achievable. It is legitimate for assets such as real estate, motor vehicles, boats, furniture and the like to be owned by the trust. The effect is that the individuals don’t own any the assets because they will all be registered in the name of the trustee in the capacity of trustee of the family trust . That effect of that is that the trustee does not be have personal title or ownership to the assets because he or she is declared simply as not having personal ownership or title to the assets but rather as trustee of the family trust. As the deed of trust is not recorded publicly it can make it difficult, if not impossible for prying eyes to find out who the beneficiaries of the trust are.
Parents may own a business that generates profits so by owning it in the name of the trust they can request the trustee to distribute the net taxable income of the business to the beneficiaries by taking into account each family members’ income tax rate. If the parents are on the highest tax rate, it may be beneficial to distribute the income of the trust to adult children who might be on a lower tax rate. If the trustee decides to distribute trust income in this way, then the children receiving the income pay tax on it in addition to their income from other sources. What the children receive from the trust, is legally their property and it is not unusual for those children, to give what they received back to the family pool for mutual benefit. In Australia, if a trustee distributes the income of the trust by the end of each financial year, then the trust itself pays no income tax. If the trustee decides not to distribute income, then the trust is required to pay tax on that undistributed income.
Having a family trust depends on and is underscored by the word “trust”. It will all work well if there is mutual co-operation and underlying trust in the family.
Disadvantages of a family trust
If there is misbehavior by beneficiaries of a family trust and trust in them is eroded, then the deed of trust can be amended to exclude those individuals, or they can remain and receive distributions in future with behavioral changes. Alternatively, the appointor can remove the trustee if that is a solution.
If assets are purchased in the name of the trust, then that is fine until the trust needs to borrow to purchase assets. Lenders are fully aware that trusts are fickle and as they want absolute security for their money, they insist that those behind the trust provide their personal written guarantees for the monies lent to the trust.
The breakdown of marriages and personal relationships can be an exposure to claims on the trust by the departing spouse in relation to the family member’s future entitlement under the trust deed. While family trusts are discretionary trusts and there is no obligation on the trustee to distribute assets or income to beneficiaries, departing spouses may try to make a claim. It is possible for the trustee to “write out” a spouse as an ineligible beneficiary anyway.
Death and the life of a family trust
By law, the trust is created on the signing of the trust deed after which the trust has a maximum life expectancy of 80 years. At the end of 80 years the trustee has to wind up trust and distribute the assets between the beneficiaries. Of course, if circumstances show that trust serves no further use or purpose then it can be wound up earlier.
There is a difference though with a company, a company cannot die. Because a company is created under government legislation it lasts forever. The death of the director does not impact on the continuance of the company’s activities. The death of the trustee does not impact on the continuance of the trust’s activities because the appointor has the power to appoint a substitute trustee.
Family trust members’ wills
Parallel with having a family trust, it is always desirable that the beneficiaries have their own wills once they reach the age of 18. A properly crafted will can have a trustee with various powers for the protection of the deceased family member’s assets. Two scenarios can arise (a) a family member dies leaving his/her assets to the spouse. The parents don’t like the idea of the in-law inheriting so by the incorporation of a family trust will, the in-law can be by-passed and the deceased’s entitlements held in trust for grandchildren. And (b) the deed of family trust and the will can be crafted to have a beneficiary’s entitlement under the will and/or deed of family trust cancelled if a beneficiary becomes bankrupt. That way the assets and benefits of the family trust are not open to claims for payment by creditors.
Family trust expenses
Having title to the family home in the name of the trustee of a family trust means that the entitlements to government taxes and charges that might normally be discounted or written off are not available unless title is with the owner occupier. Having the family home in the name of the trustee can also mean that capital gains tax is applied to a profit on sale in Australia. One way to overcome this happening is for the family home held in the names of the parents and with the establishment of an asset protection trust, the equity in the property is mortgaged to a trust so that equity is protected against claims by creditors and whatever government charges apply to the home’s owner, are retained and capital gains tax is avoided.
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