Family trusts have sparked public disputes among some of Australia’s wealthiest families. But how do they function, and is starting a trust an option for everyone?

The nation’s richest individual, Gina Rinehart, has been engaged in a protracted legal fight with her children over a family trust lasting over a decade. Similarly, the Murdoch family’s trust plays a pivotal role in their ongoing succession saga.

What is a Family Trust?

A family trust is an arrangement where a person or entity agrees to hold assets for the benefit of another person or entity. It is a kind of discretionary trust, allowing the trustee, often the parents, to decide how to distribute income.

Typically, trusts provide annual income distributions to beneficiaries, who must then pay tax; the trust itself is usually not taxed directly.

Beneficiaries can be individuals or companies, typically family members like spouses or children, entitled to the trust’s income or capital. Tax liabilities are generally based on the beneficiaries’ share of the trust’s net income.

There are several practical, commercial, and financial reasons for choosing specific distribution methods within a trust. Income may often be allocated to family members with the lowest taxable income to minimise tax burdens. However, it’s important to note that this process may not always be straightforward.

What is the Purpose of a Family Trust?

A family trust provides flexibility in managing investment portfolios, family wealth, business operations, and can help reduce tax liabilities.

The primary advantage is tax reduction. Parents can distribute income to children in order to take advantage of tax-free thresholds.

• If a trust holds an asset generating income, it can be distributed among family members to effectively utilise the $18,200 tax-free threshold. For instance, with three children, that amounts to $60,000 tax-free.
• Another advantage is asset protection from creditors and legal claims.

In family trusts, the trustee, rather than individual beneficiaries, controls and manages the assets. This structure can provide significant asset protection in certain situations, such as if a family member faces legal action.

Family trusts are also instrumental for estate planning. Through a family trust, the ownership of assets like share portfolios or holiday homes can remain intact even after the death of a key family member, since the trust—not the individual—owns the assets, preventing them from being included in the individual’s estate.

When is a Family Trust Beneficial?

A family trust can be advantageous for individuals wanting to invest a considerable amount, especially if they’ve maximised super contributions or seek greater access than superannuation allows. For certain professions, notably those with a higher litigation risk, family trusts offer an additional layer of asset protection.

For instance, medical professionals, financial advisors, and consultants are often at a higher risk of legal action. Establishing a family trust can safeguard their assets. Additionally, younger investors may find family trusts an appealing and flexible investment avenue.

Unlike super contributions that are locked until retirement age, family trust assets can be accessed whenever needed, although capital gains tax must be considered when trust assets are distributed as cash. Family trusts are also attractive for families aiming to keep their assets within the immediate family.

When is it Not Worth Setting Up a Family Trust?

The fundamental criterion for establishing a family trust is having assets to place within it. The decision should focus more on personal circumstances and financial goals rather than strictly a specific investment amount. Key factors to consider include the costs associated with managing the trust and the desired level of asset protection.

For example, ongoing accounting fees and annual tax returns may not justify the establishment of a trust. Additionally, for investment portfolios, the income generated should be sufficient to make the splitting of income between spouses economically beneficial.

How Does a Trust Work?

Scenario 1: Without a Family Trust

Judy earns $160,000 annually. That year, she sells her investment property for a post-tax amount of $800,000 and reinvests the proceeds, generating an income of $40,000. This results in a taxable income of $200,000 for the year, and with an effective tax rate of 32%, she pays $64,000 in taxes.

Scenario 2: With a Family Trust

Now, if Judy establishes a family trust with the same earnings and proceeds, she invests the $800,000 through the trust, which also generates $40,000 in income. This amount is equally distributed to her two adult children, John and Rehana, who, being students with no income, incur no tax liabilities.

Judy’s taxable income remains $160,000, resulting in a tax payment of $47,000. Consequently, the effective tax rate is 29%, lower due to reduced taxable income and applicable thresholds. By setting up the family trust and distributing a portion of the income to her children, Judy effectively saves $17,000 in taxes for that financial year.

For more information about tax implications related to family trusts, visit our Tax FAQ page.