Family (Discretionary) Trusts

This month’s Wealth Pipeline discusses Family Trusts.  

Family (Discretionary) Trusts

A trust structure requires:

• Trustee(s);
• Beneficiaries; and
• Trust property (assets).

Trust property is held on trust by the trustee for the benefit of the beneficiaries.  This means, the trustee is the legal owner of the trust property.  Beneficiaries are entitled to the benefit of the trust property.  There are many obligations imposed on trustees, including acting in the utmost good faith and avoiding conflict transactions.  Conflict transactions arise where the trustee has personal interests, which do not align with the best interests of the beneficiaries.  Trusts are governed by relevant legislation and the terms of the trust deed.

A family or discretionary trust is a trust where the beneficiaries do not have a fixed entitlement or interest in the trust property.  The trustee has the discretion to determine which of the beneficiaries are to receive the capital and income of the trust and how much each beneficiary is to receive.  It is important to note the trustee does not have a complete discretion.  The trustee may only distribute to beneficiaries within a nominated class as set out in the terms of the trust deed. 

As our primary focus is private wealth, our commentary has focussed on family trusts holding investment assets rather than owning businesses.

Advantages of discretionary trusts

The main advantages of discretionary trusts include:

• Estate planning:  Similar to assets held as joint tenants or within super, trust assets do not automatically form part of a beneficiary’s estate upon death.  This makes family trusts a very effective estate planning vehicle, particularly where it is envisaged a family provision claim is likely.   
• Tax minimisation:  The trustee’s discretion to distribute trust property to beneficiaries means that they can cherry pick to whom, and in what amounts they distribute income.  It should however be noted that the tax free threshold for minors is presently only $416, and the 2012 financial year was the final period that minors were eligible for the low income rebate.   
• Asset protection:  As noted earlier, beneficiaries of a discretionary trust do not beneficially own the trust’s assets before the trustee makes an allocation to them.  This means that a creditor of a potential beneficiary cannot gain access to the assets in the discretionary trust to help satisfy a debt owed to them by the beneficiary (unless the trustee makes a distribution to that beneficiary).

Disadvantages of discretionary trusts

Disadvantages of discretionary trusts include:

• Land Tax:  The land tax threshold for individuals in Queensland is $600,000 versus $350,000 for trustees. 
• Control in the wrong hands:  Although family trusts can be very effective estate planning tools, they are subject to the efficacy of the trustee. 
• Trusts cannot distribute tax losses:  For example, if a trust held a negatively geared property and earned no other income during the financial year to offset the loss against, it cannot distribute the tax loss amongst beneficiaries.
• Extra administrative burden:  Trusts will cost more to run than if the assets were personally held.  Furthermore, trustees must determine and document how they are going to distribute income prior to the end of each financial year.
• Trusts do not last forever:  In Queensland trusts may last for up to 80 years.
• Centrelink:  Centrelink recipients can be assessed not only on the trust distributions they receive, but the whole of a trust distribution.  They can also be assessed with the assets held within a family trust.  Centrelink and family trusts is a complex area.  
• Legislation risk:  There is always talk that trusts should be taxed like companies.  
• Unattractive tax rate:  Undistributed income from trusts is taxed at 49% including Medicare. 

​Our Comments

Whether a family trust is appropriate for anyone needs to be carefully considered.  There are however some situations where a family trust has a clear strategic advantage compared to other structures.