Family trusts can be a very tax effective way of managing wealth, and a useful part of an overall strategy for wealth accumulation and asset protection, say Michael Hutton and Peter Bembrick
Family trusts are not always well suited to retirement planning needs – a self-managed superannuation fund (SMSF) is usually a better vehicle for providing retirement income, although by the same token, some people think that an SMSF will meet all their needs for both retirement planning and wealth accumulation, but this isn’t always the case.
The advantages of SMSFs are fairly well known. They offer significant tax benefits – tax is paid at just 15 per cent while wealth is being accumulated, and there is no tax payable when drawing down a pension.
They also have excellent wealth preservation features, primarily as it is difficult for creditors to get access to money within superannuation.
But members of SMSFs are unable to access the funds until they reach a certain age, and there are other restrictions, including what assets can be held in SMSFs or who can be members, and this can be limiting.
The advantages of family trusts, on the other hand, are not so well known.
What are family trusts?
Family trusts are discretionary trusts where an election has been made and lodged with the Tax Office that restricts potential beneficiaries of the trust to family members.
This can include a broad list of relatives within two generations. Beneficiaries have no right to the assets owned by the trust, which are controlled by the trustees who run the trust according to the rules laid down in the trust deed.
Income is distributed at the absolute discretion of the trustees.
Some uncertainty has surrounded trusts lately regarding income streaming. This has now been largely cleared up with the Government passing legislation allowing streaming of capital gains and franked distributions for the 2011 and future financial years.
The Government has also announced that it will undertake a complete rewrite of the tax law dealing with trusts, in an effort to provide greater certainty to trustees and beneficiaries, and this is expected to happen in the next six to 12 months.
Unlike SMSFs, trusts have no contribution limits, can hold assets for future generations, and there are usually no restrictions on what a trust can invest in or on how much it can borrow (unless specified by the trust deed).
In addition, beneficiaries of trusts don’t need to wait for retirement to sell assets and access cash – the money is not locked away.
When the person who set up or controls the trust dies, this control can be easily transferred to the next generation with no immediate tax consequences. With an SMSF, a member’s death can trigger a taxable capital gain for his or her beneficiaries.
The ability of family trusts to provide protection for family and business assets – for instance, in circumstances of business failure or family disagreements – should not be underestimated.
When assets are owned by a trust, it can be difficult for creditors to gain access to them; so trusts can be a very attractive option for small business owners such as printers.
Trusts are most beneficial when one family member is on the top marginal tax rate. Instead of owning assets in that person’s name – and paying the top tax rate on income they generate – the investments can be owned by the trust and income distributed to lower income earners in the family.
The main drawback of a trust is the possibility of family disagreements about who is in charge. There can also be complications in estate planning.
Trust assets do not form part of an estate. For example, a beneficiary might indicate in a will that any distribution from a trust go one way, whereas the trustees might decide to send it another way, as they have a duty to act in the interests of all beneficiaries.
Perhaps the best approach is to use a combination of a trust and an SMSF to manage wealth. Superannuation has its virtues until contributions caps cut in, at which point family trusts may become a good option.
* Michael Hutton and Peter Bembrick are both partners with accountants and business and financial advisers HLB Mann Judd Sydney