Pink piggy bank with gold coins surrounding it

Do I need a family trust? Probably not.

There are various types of trusts. This article uses general terminology but is probably most relevant in terms of family discretionary trusts, unless otherwise specified.

Trusts have a few purposes. This article covers three of the main ones:

  • Asset protection
  • Taxation
  • Testamentary intention

In the most basic sense, the asset protection element arises from the nature of the relationship between the trustee and the beneficiaries. That is, the asset is not actually held by the beneficial owner, it is held by the trustee for that person. If the beneficiary is made bankrupt or dies, the assets of the trust ideally should not be disturbed. This concept is what probably underlies the everyday understanding of the need for ‘a trust’, in addition to somehow being a ‘tax vehicle used by the rich to hide their wealth from the taxman’ (news flash – they are not!).

Jokes aside, there are a few misconceptions when it comes to trusts and asset protection that we should dispel right now:

You cannot set up a trust simply to avoid your spouse or partner taking an interest in those assets.

The Family Court of Australia has far-reaching powers when it comes to property within its jurisdiction and Courts tend not to hesitate when it comes to exercising their powers in relation to trusts if there is even a whiff of foul play. That said, there are plentiful cases where a spouse has sought orders to include trust assets in the matrimonial pool and failed.

You cannot transfer assets into (or out of) a trust (or anywhere for that matter) to avoid creditors or a spouse.

The Family Law Act, Bankruptcy Act and the Corporations Act all contain wide-ranging ‘claw back’ provisions (and penalties) in relation to transactions designed to defeat creditors or a spouse. In fact, any asset transferred by an insolvent corporation or bankrupt person is liable to be clawed back, irrespective of the stated reason, provided certain criteria are met.

In addition to these misconceptions, it is also worthwhile noting that most prudent lenders require personal guarantees from the trustee and/or beneficiaries when lending to a trust. So, if the trust is borrowing money to purchase an asset, the asset protection function is largely lost because the principals will probably be personally liable to the biggest creditor (the bank) anyway. That said, after the bank, the trust structure can afford some level of protection from other creditors of the beneficial owner.

When are trusts actually useful for asset protection purposes?

Trusts are used by business owners all the time. Provided that are set up correctly, they can provide protection to the business owner from the exposure of the business and vice versa.

For asset protection purposes, the trust vehicle will be most effective if it is set up when the asset is originally acquired or established. For example, when a property is originally purchased (say for cash), or when a business interest is acquired or started (such as a ‘start-up’).

For family law purposes, even these protections may be lost if the spouse in question is the trustee or the appointor, can exert some level of control over the trust or has received a distribution from the trust.

A trust may also be established so that business owners can hold their business interests in different ways and assign different levels of ownership, such that a trust can be used to add layers of ownership – in addition to the share classes already available to shareholders. So, it may be prudent from a risk or administrative perspective for some equity holders to have an interest in a trust, rather than holding shares. Under the Corporations Act, shareholders have the ability to seek winding up orders, on certain grounds. Arguably, it is more difficult for a beneficiary of a trust to wind up a trust than it is for a shareholder to wind up a  company.

Taxation and family trusts

Any asset protection benefit needs to be weighed against the taxation consequences of such a structure. For instance, corporations do not obtain the benefit of certain Capital Gains Tax (CGT) discounts/exemptions that individuals might receive. Neither a trust nor a corporation can have a ‘principal place of residence’ and so that CGT (and land tax) exemption is lost if the property is supposed to be a home for the individuals but is held by a corporation or trust instead.

In the case of investment properties, in very general terms, individual investors can lose the full benefits of negative gearing, CGT discounts and land tax thresholds if they purchase their investment in a trust. These lost benefits may outweigh any benefit gained from asset protection.

The most common taxation benefit arising from trusts is the ability to ‘income stream’. This means that income from dividends or rent etc. can be distributed to more than one person or into bucket companies. The benefits here include:

  • Taking advantage of income tax thresholds and marginal tax rates between multiple individuals
  • Delaying the incurring of tax at higher rates by timing the actual receipt of the income

If you do not have anyone to distribute income to, other than yourself, a trust is pointless for income streaming purposes.

In some cases, a trust may be used like a bank and instead of distributing income that is taxed at a certain tax rate the trust loans the money instead.

Testamentary intent

A testamentary trust is a valuable tool for both asset protection and tax planning. Because the trust is established as a result of the death of the testator, the issues highlighted above concerning asset protection are virtually non-existent. This is provided that the will of the deceased is not challenged and no orders are made about the assets of the deceased estate. Courts have certain powers under the Succession Act (NSW) in relation to assets of an estate.

In the case of a testamentary trust, an owner of a property or other assets (such as shares) can give the assets to their executor (as trustee) to hold on trust for whomever they please. A common situation is where a spouse would like to ensure that their children ultimately receive their share of a property because they are concerned their surviving partner might remarry after they die.

Here, it is perfectly reasonable to allow the surviving spouse to remain in the property for their lifetime, without him/her ever actually receiving ownership of the deceased’s share. Once both parents pass away, the children receive the full inheritance. The benefit here is that if the surviving spouse remarries there is reduced ‘dilution’ of the inheritance for the children. In a similar fashion, a parent concerned about their child’s spouse may elect to establish a trust for their grandchildren instead, whilst granting benefits to the family, such as a stipend.

From a tax planning perspective, if the terms of a testamentary trust are appropriately worded, an income-generating asset can be held in a trust with tax planning in place and thereby achieve a number of tax objectives.

Things to consider when setting up a trust

There are myriad factors to consider if a trust is right for you. Here are a couple of basic things to think about.

  • Why do I want to set up a trust?
  • Is the structure capable of providing the benefits I am looking for?
  • What are the benefits of setting up a trust, given my circumstances?
  • What taxation or other consequences might arise for me in setting up a trust as opposed to another structure?

Something to think about.

It would be foolish to take anything in this article seriously, let alone act on any of the contents of this article. This article contains general information only and is not to be considered legal or taxation advice. The writer expressly disclaims any expertise when it comes to taxation let alone any understanding of the tax system. The legal information in this article is not to be relied upon or used in any way, other than for information purposes only.

You should always obtain independent legal and accounting and financial advice that takes into account your personal situation and objectives before setting up a trust or any kind of legal structure.