What is a family trust?
A family trust is a trust established during the lifetime of a person. It is sometimes referred to as an “inter vivos” trust. Commonly the term refers to a discretionary trust that has beneficiaries from a specific family, and the beneficiaries often include related entities (such as companies and other trusts) of those family members. However, technically the term “family trust” refers to a certain type of discretionary trust, namely one that has made a family trust election for taxation purposes. For the purpose of this article, we use the term family trust to mean any discretionary inter vivos trust.
How do you know what type of trust you have?
The only way to know what type of trust has been set up is to read the trust deed. It is important to not assume that a trust referred to as “The Smith Family Trust” for example, is a family trust. ‘Family trusts’ are often confused with will trusts, fixed trusts, bare trusts or even self-managed superannuation funds. By reading and reviewing the terms of the trust deed, the type of trust will become apparent.
Why use a family trust?
Taxation: Family discretionary trusts provide flexibility to distribute income and capital amongst multiple persons and entities in order to take advantage of each beneficiary’s particular tax circumstances. For example, distributing income to a spouse who is not working may result in a significant tax saving. However, family trusts are not effective income distribution vehicles for minor beneficiaries.
Asset protection: The assets of the family trust are separate from the beneficiary’s personal assets, meaning that (usually) if a beneficiary is sued, or, the assets are not easily included in any proceedings thus providing an additional asset protection advantage over direct ownership. In the event of separation from a spouse, a family trust which was established prior to the relationship, and capitalised prior to the relationship, may be quarantined from the relationship assets in the event of breakdown. However, this is not a black and white rule and very careful advice and planning needs to be put in place to prevent a trust from being within the reach of the Family Court.
Succession planning: A family trust can be a useful long-term succession vehicle, for passing control of family assets to one or more family members, rather than giving the assets to individuals outright. They hold the family asset on trust for themselves, and their families, and the next generation/s.
Estate Planning for Family Trusts Considerations
If you have a Family Trust what do you need to do as part of your estate planning?
The first thing to remember is that the assets of your family trust are not your personal assets, this means that if you attempt to dispose of family trust assets via your will, this will be ineffective. Rather than gifting the assets of the trust, the focus is generally on the passing of control after the present controller dies.
Typically, most family trusts have two critical roles, the role of the Appointor and the role of the Trustee. The Trustee is the person/s or entity which administers the trust day to day. The Trustee decides how income is distributed, how funds are invested etc. The Appointor is the person/s or entity that has the power to ‘hire and fire’ the Trustee. Hence, the Appointor is in fact the most powerful role in a family trust. Sometimes the role of an Appointor is referred to as ‘Principal’ or other like term. The powers of such roles are typically the same.
By reviewing your trust deed, your lawyer will be able to ascertain who the current controller of your trust is and who will, by succession, become the controller of the trust in the event of your death, retirement, or incapacity. It is important that trust deeds address not only the death of a trustee and appointor but also other situations in which they may not be able to act, for example in the event of a loss of capacity.
Where a trust has more than one trustee or appointor, or you intend to appoint more than one successor trustee or appointor, it is also important to review how decisions are to be made, for example unanimously or by a majority. This is common where parents are looking to appoint all of their children jointly as successors of the trust. Where a decision cannot be reached, i.e. in the event of a dead lock, what provisions does the trust deed have to deal with such disputes. A thorough review of your trust deed will usually identify these issues and suggest dispute resolution mechanisms to mitigate the risk of disputes ending up in the Supreme Court.
Another important consideration is the review of beneficiary loan accounts as part of a succession planning exercise. Accountants usually aim to distribute income of a trust in the most tax effective manner amongst beneficiaries. Where these distributions are recorded in the financials but not physically paid out to the beneficiaries (for example, parents distributing income to adult children to reduce tax), these beneficiaries are entitled to call for those unpaid amounts. This can be a problem in a succession planning context (as well as family law) as sometimes large sums of money are owed to individuals who subsequently pass away, and the trust is left to find the cash to pay out these loan accounts to the estate of the deceased person.
If you do have beneficiary loan accounts in your trust you will need to work with your lawyer and accountant to ensure that they are dealt with appropriately.
How do you know if your family trust has been reviewed for succession planning purposes?
Your estate planning lawyer should be asking you for the following as part of your estate planning for family trusts:
- A copy of your Trust Deed including any amending deeds
- A copy of your most recent Trust financials, and;
- Confirmation from your accountant regarding:
- beneficiary loan accounts,
- Division 7A issues, and
- whether or not a Family Trust Election has been made.
As family trusts often hold a large proportion of wealth, it is critical that these structures are reviewed to ensure that the right people take control of the trust and that any monies owing by the trust to beneficiaries are addressed.
About the author: Karolina Rzymkowska is a Perth Lawyer and Head of Estates at Lynn & Brown Lawyers. Karolina leads the Estates Team and is highly experienced in both simple and complex estate planning, estate administration and disputed estates.