What is a family trust and are they tax effective structures?

This is quite far from the truth and the ‘family trust’ structure is quite common in Australia. In fact we have one ourselves which we use for the purpose of running our business.

So what is a family trust? The term ‘family trust’ actually refers to a discretionary trust which is set up to hold a family’s assets or to conduct a family business. The concept of a trust requires a bit of explanation but to explain it at a high level, it means another entity ‘holds’ money on behalf of someone. The ‘discretionary’ aspect of it relates to how profits are distributed in the trust.

There can be a lot of reasons to set up a family trust but today I will talk about the main reasons for setting up a family trust. These are either as a vehicle for your family business or as an investment vehicle.

FAMILY BUSINESS
Depending on your circumstances, a family trust may be a good vessel for your family business. The major benefit or this type of trust structure is that profits can be distributed at the trustee’s ‘discretion’ meaning that at the end of the tax year, the owner of the business can distribute the profits to the most tax effective people (those with the lower income). The disadvantage of this structure as opposed to other structures is that distributions need to be made yearly otherwise the tax on the money that remains in the trust structure is taxed at the top marginal rate.

A family trust can also be beneficial from an asset protection point of view. As the trust is a separate legal entity, the assets of the trust are not tied up with your personal assets as would be the case if you were a sole trader etc. The one thing to note though is that if you are the ‘trustee’ of the trust, this may not be as effective. A common approach is to make a company the trustee of the trust with you as a director of the company. Again there are pros and cons to this approach and you should seek good advice before considering any such action.

INVESTMENT VEHICLE
Another common use of a family trust is as an investment vehicle. Those who set up such a trust are usually seeking the option to distribute profits at their discretion to family members in the most tax-effective way. In addition, the investor may wish to obtain asset protection benefits in circumstances where they wish to retain control of the asset (for example where they purchase a house for their child and their partner using the trust and they subsequently divorce).

It should be flagged that there are very strict rules on distributions to minors which can limit the effectiveness of distributions to all family members. Further, there are reasonably substantial compliance and accounting costs in keeping a family trust which need to be considered with reference to the potential benefits from tax-effective investments.

Whether a family trust is appropriate for you will depend on your particular circumstances. Once again getting good financial advice will ensure that you are taking advantage of all investment and structuring options available to you to ensure you achieve your goals sooner.

As always, if you have any questions let me know below.

This post is from Ben Brett. Check out our details in the About Us page.

Posted in: Ben Brett, Financial Planning, and Investments