Trusts are a popular legal structure in Australia, used for various purposes such as asset protection, tax planning, and estate management. They are a fundamental element in the planning of business, investment, and family financial affairs. Trusts are a common strategy, and this article aims to aid a better understanding of how a trust works, the role and obligations of a trustee, the accounting and income tax implications, and some of the advantages and pitfalls. Of course, there is no substitute for specialist legal, tax, and accounting advice when a specific trust issue arises, and the general information in this article needs to be understood within that context.
What is a Trust?
A trust is a legal arrangement where one party, known as the trustee, holds and manages assets for the benefit of another party, the beneficiary. Trusts are governed by trust deeds and relevant laws, such as the Trusts Act in various states and territories. The trustee has a fiduciary duty to manage the trust’s assets in the best interests of the beneficiaries.
Interestingly, the concept of trusts dates back to medieval England. Knights who went on crusades would leave their property in the care of trusted friends or family members, ensuring their assets were managed according to their wishes while they were away.
Types of Trusts in Australia
Fixed Trusts
Fixed trusts are straightforward. The beneficiaries have a predetermined and fixed entitlement to the trust's income or capital. This means the trustee doesn't have discretion over how income and capital are distributed. For example, in a family situation, each child might receive an equal share of an inheritance, providing certainty and fairness in asset distribution.
Fixed trusts are often used in estate planning to ensure that assets are distributed exactly as intended, without any changes or discretion by the trustee.
Unit Trusts
Unit trusts operate similarly to companies. The trust’s property is divided into units, much like shares in a company. Beneficiaries, known as unitholders, have entitlements proportionate to their units in the trust. This structure is commonly used for investments, such as property or managed funds. Investors pool their money to purchase units in a trust that owns commercial property, and income is distributed based on unit holdings.
Unit trusts are popular in the investment world because they allow multiple investors to pool their resources, making it easier to invest in large-scale projects like commercial real estate.
Discretionary Trusts (Family Trusts)
Discretionary trusts, often referred to as family trusts, give the trustee discretion over how to distribute the trust’s income and capital among the beneficiaries. This flexibility is beneficial for managing assets, tax planning, and protecting family wealth. For instance, a family trust might be set up to distribute income among family members, optimizing tax outcomes and protecting assets.
Discretionary trusts are highly flexible and can be tailored to meet the changing needs of a family, making them a popular choice for long-term wealth management.
Bare Trusts
Bare trusts are quite simple. The trustee holds assets on behalf of the beneficiary without discretion. The beneficiary has full control and can demand the transfer of the assets at any time. These trusts are commonly used for holding assets for minors or specific SMSF transactions, such as property investments under a limited recourse borrowing arrangement (LRBA).
Bare trusts are often used in SMSFs to hold property under a limited recourse borrowing arrangement, allowing the SMSF to borrow money to buy property while limiting the lender's recourse to the property itself.
Hybrid Trusts
Hybrid trusts combine features of both discretionary and fixed trusts. They provide a mix of fixed entitlements and discretionary distribution powers. For example, a hybrid trust might ensure a disabled beneficiary receives a fixed income while other family members receive discretionary distributions, offering flexibility in asset management.
Hybrid trusts are versatile and can be structured to meet a variety of needs, making them suitable for complex family and financial situations.
Testamentary Trusts
Testamentary trusts are created by a will and only come into effect upon the death of the testator (the person who made the will). These trusts are often used in estate planning, particularly for minor children or dependents who require controlled asset distribution. For instance, a testamentary trust might be set up to ensure minors receive their inheritance in a controlled manner until they reach adulthood.
Testamentary trusts can provide significant tax advantages, as income distributed to minor beneficiaries is taxed at adult rates, rather than the higher rates that usually apply to minors.
Superannuation Trusts
Superannuation trusts operate as superannuation funds, including SMSFs, providing retirement benefits to members. These trusts allow for significant control over investment decisions. For example, an SMSF allows members to directly control the investment strategy and asset allocation, providing retirement benefits while maintaining control over investments.
Australia has one of the largest superannuation systems in the world, with assets totaling over $3 trillion, much of which is held in superannuation trusts.
Special Disability Trusts
Special disability trusts are designed to provide for the care and accommodation of a person with a severe disability. These trusts offer social security and tax benefits, ensuring long-term care and support for disabled individuals. For instance, a special disability trust might hold assets to fund a disabled person’s care without affecting their social security entitlements.
Special disability trusts were introduced by the Australian government to help families provide for the long-term care of disabled relatives without jeopardizing their access to social security benefits.
Charitable Trusts
Charitable trusts are established to support charitable organizations or causes on a continuing basis. These trusts provide ongoing support to charitable activities, often with tax advantages. For example, a charitable trust might fund scholarships or other charitable activities, providing long-term benefits to the community.
Charitable trusts can provide significant tax benefits to donors, as donations to these trusts are often tax-deductible.
Trusts for Accommodation – Life Interests and Right of Residence
These trusts provide accommodation benefits, either for life or a specified period. They ensure a family member has a place to live, particularly after the death of the primary breadwinner. For instance, a trust might allow a spouse to live in the family home for life after the death of the other spouse, with the remainder passing to children after the spouse's death.
Trusts for accommodation can be a vital tool in estate planning, ensuring that loved ones have a secure place to live even after the primary breadwinner has passed away.
Trusteeship in SMSFs: Individual Trustees vs. Corporate Trustees
When establishing an SMSF, one of the key decisions is whether to appoint individual trustees or a corporate trustee. The choice between these two options can significantly impact the SMSF's operation, legal liability, administration, and succession planning.
Individual Trustees
An SMSF with individual trustees requires each member of the SMSF to also be a trustee. This structure is simpler and less costly to establish but comes with certain limitations and risks. For instance, individual trustees are personally liable for decisions and actions, exposing them to personal liability risks if the SMSF is sued or penalized. Additionally, if a member dies or exits, the SMSF must appoint a new trustee, adding complexity and potential costs.
Individual trustees must be members of the SMSF, ensuring that all decisions are made by those who have a direct interest in the fund's performance.
Corporate Trustees
A corporate trustee involves a company acting as the trustee for the SMSF, with each member serving as a director of the company. This structure is more flexible and provides better legal protection but involves higher costs. The corporate trustee structure separates the fund’s assets from the personal assets of the members, providing a layer of protection. It also makes it easier to manage changes in membership, as there is no need to change asset titles if a member leaves or dies.
Corporate trustees can continue to operate even if a member dies or leaves the SMSF, providing greater continuity and stability for the fund.
Choosing the Right Trust and Trustee Structure
The choice of trust type and trustee structure depends on various factors, including the purpose of the trust, the nature of the assets involved, the needs of the beneficiaries, and the desired level of control and flexibility. For example, a discretionary trust with individual trustees might suit families seeking direct control and flexibility in distributing family wealth. On the other hand, a unit trust with a corporate trustee could be ideal for investors pooling investments and seeking asset protection.
Understanding the different types of trusts and the roles of trustees is crucial for effective financial planning, asset protection, and tax management in Australia. Whether you are considering setting up a trust for family wealth management, investment purposes, or retirement planning, choosing the right structure and trustee is essential for achieving your financial goals. If you found this article help please share it or like it on Facebook, you can book an appointment in either Melbourne or Gold cost by clicking the link>>
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