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Keeping Wealth in the Family

For most families, preserving and enhancing the family wealth and passing it on to future generations is a primary goal. There are a number of ways of achieving this, including the use of family trusts.

Trusts can be very powerful tools in protecting and distributing family assets in a tax effective manner.

A trust is an agreement where a person or a company (the trustee) agrees to hold an asset or assets for the benefit of others (beneficiaries). The trustee is the legal owner of the trust asset/assets and the beneficiaries hold the beneficial interest in these assets.

There may be a variety of reasons for using trusts. The use and the structure depend on the purpose of the trust.

The family trust:

  • Is established by a family member for the benefit of members of the family group;

  • Can be subject to a Family Trust Election;

  • Provides protection from potential liabilities (bankruptcy or insolvency);

  • Allows for family assets to pass to future generations in a tax effective manner;

  • Can be a tax effective vehicle by ensuring all family members use their tax-free thresholds for income tax purposes; and

  • Can provide certainty in the event of a family member's death by avoiding issues such as challenges to the will.

Who may be included in the family group?

Section 272-95 of the Income Tax Assessment Act (ITAA) 1936 sets out the family of an individual (the test individual) as:

a) Any parent, grandparent, brother or sister of the test individual or the test individual's spouse;

b) Any nephew, niece or child of the test individual or the test individual's spouse;

c) Any lineal descendant of a nephew, niece or child referred to in paragraph (b);

d) The spouse of the test individual or of anyone who is a member of the test individual's family because of paragraphs (a), (b), and (c).


  • A child includes the individual's child, adopted child, ex-nuptial child, stepchild, a child of the individual's spouse, a child of the individual within the meaning of the Family Law Act 1975.

  • A spouse includes current spouse, former spouse, de-facto spouse (whether of the same sex or a different sex).

  • The term lineal descendent includes any descendent of an individual in a direct line relationship flowing downwards, starting with an individual's child (including an adopted child, stepchild or ex-nuptial child) and extending to include a grandchild, a great grandchild and so on.

In addition, section 272-90(2A) of the ITAA 1936 extends the family group further to include:

a) A person who was a spouse of either the primary individual or of a member of the primary individual's family before a breakdown in the marriage;

b) A person who was a widow or widower (whichever is applicable) of either the primary individual or of a member of the primary individual's family and who is now the spouse of a person who is not a member of the primary individual's family; and

c) A person who was a step-child of either the primary individual or of a member of the primary individual's family before a breakdown in the marriage of the primary individual or the member of the primary individual's family.

Types of trust

Generally speaking trusts can be:

  • Fixed;

  • Discretionary; or

  • Hybrid

In a fixed trust, the share that beneficiaries have in assets and income are pre-determined and fixed. This structure does not give the trustee any flexibility in varying income or capital distributions.

An example of fixed trusts can be unit trusts (also known as managed investment funds) where each unit held in the trust represents an entitlement to a certain proportion of income and capital.

The fixed trust is not a very common structure used in family trusts.

A discretionary trust provides the trustee with discretion over the distribution of trust income and capital in accordance with the terms of the trust deed. Discretionary trust structures are very common amongst family trusts due to the flexibility that they offer.

A hybrid trust has characteristics of both fixed and discretionary trusts. An example of a hybrid trust can be a unit trust with discretionary distribution options or a discretionary trust with certain fixed entitlements being fixed by the trust deed.

The use of this structure can be beneficial for specific purposes such as fixing a percentage of entitlement to a particular beneficiary/beneficiaries for a specific reason.

Trusts established for family affairs are usually testamentary or inter vivos trusts.

Testamentary trusts (also known as discretionary will trusts) are established in a will and do not come into effect until the will maker's death.

In contrast, inter vivos trusts (also known as living trusts) are an arrangement provided by the will and allow the will maker to pass on their assets while still alive.

Note: When the trust income is distributed to a minor (under age 18), the taxation treatment of a discretionary will trust should be distinguished from an inter vivos or living trust. This is explained further in the Financial Planning Opportunities section of this article.

Taxation of family trust income, franked distributions and capital gains

Trust Income: The trustee of the family trust must distribute the taxable income generated by the assets of the trust to the beneficiaries. Income that is distributed to beneficiaries forms a part of the beneficiary's taxable income and is taxed at their marginal tax rate. Any income retained by the trust (also known as undistributed income) is taxed at the top tax rate of 45 per cent, plus Medicare levy of two per cent, plus Budget Repair levy of two per cent. This gives a strong incentive to family trusts to fully distribute the trust's income before the end of each financial year.

Franked distributions: Where provided by the trust deed, franked distributions can be allocated to beneficiaries by making them specifically entitled to these distributions. The beneficiary will be taxed on the distribution and also receive the benefit of any franking credits.

Capital gains: Similar to franked distributions, the capital gain generated by the disposal of a trust asset, can be allocated to beneficiaries for tax purposes. This is done via the trust deed by making beneficiaries specifically entitled to it.

Financial planning opportunities

There are a number of advantages in using family trusts including income splitting, asset protection, and estate planning, as outlined below.

Income splitting and distribution of income within family group

When the trust income is distributed to beneficiaries, the trustee must take into account each beneficiary's financial, taxation and personal circumstances and distribute available income in the most tax effective manner.

When it comes to distributing trust income to a minor, the assessment of income is determined by the type of the trust.

Any income distributed from the living trust to a minor is assessed as "unearned income" and is taxed at "minor tax rates", which are higher when compared with adult tax rates.

The amount of unearned income that a minor can earn before penalty rates of tax apply is $416. Income over this threshold is taxed at 68 per cent up to $1307, after which income is taxed at 47 per cent and the minor is not eligible for the low income tax offset.

With this in mind, it may be more tax effective to distribute most of the living trust income (if not all) to adult beneficiaries, including senior family members who may be able to take advantage of the seniors and pensioners tax offset.

In addition, beneficiaries with lower taxable income may be distributed more income than those with higher taxable income. The trustee must take these issues into consideration when distributing the trust income to its beneficiaries.

In comparison to living trusts, penalty tax rates do not apply to testamentary will trust income distributed to a minor, which includes assessable income of a trust that resulted from a will, codicil or intestacy, or a court modification of a will, codicil or intestacy (ITAA36 s 102AG).

When this applies, adult tax rates are applied to income distributions paid to a minor and the low income tax offset will also apply.

When combined with a carefully drafted trust deed, income splitting and the distribution of income within the family group can allow for the tax-effective treatment of estate assets and the distribution of the trust income.

Asset Protection

The trustee of a discretionary trust holds assets for the beneficiaries. The trustee does not personally own these assets. As such, the assets held by a person as trustee cannot be taken by creditors in the event of a trustee declaring bankruptcy or insolvency unless the debt relating to the creditors was a trust debt.

In addition, beneficiaries do not own any of the trust assets until such time when the trustee exercises its discretion to make a distribution of assets.

In situations where the debt relating to the creditors is the primary beneficiary's debt, the trustee would administer the trust fund on the primary beneficiary's behalf until such time as the primary beneficiary is discharged from bankruptcy or settles other claims against him/her. The primary beneficiary could then assume the trusteeship of the trust.

Estate Planning

One of the main advantages of using the trust structure is that it allows assets of the family to be passed on to future generations in a tax effective manner. This can be arranged while the person is still alive (living trust) or after their death (testamentary will trust).

A testamentary will trust is a trust established after the death of a person. Provision must be made in the deceased's will to establish the trust.

Testamentary trusts are a useful estate planning tool, particularly where young children are involved as it can help to minimise the tax for the surviving parent or provide management of a child's inheritance.

As different children may have different needs, it may be worth establishing more than one testamentary will trust. The will can specify that a testamentary trust must be established or allow the executor to decide if it is in the interest of the dependents based on the circumstances at that time.

The following advantages and disadvantages must be taken into consideration when recommending testamentary will trusts:

Advantages of using a testamentary will trust include:

  • Asset protection;

  • Flexibility for the distribution of income and capital (if discretionary);

  • Tax planning as income received by a child will be taxed at adult tax rates;

  • Can restrict access until the child reaches a specified age.

  • Disadvantages of a testamentary will trust include:

  • The cost of establishing and maintaining the trust;

  • The trustee has full discretion and some beneficiaries may not be provided for in accordance with the deceased's wishes if the trustee favours one beneficiary over another;

  • Loss of control by the beneficiary until the trustee makes a distribution.


The trust structure can be a powerful tool in protecting and distributing family assets in a tax effective manner.

However the establishment and the structure of the trust must be carefully considered and as such professional legal, accounting and financial advice must be sought to ensure that the trust is established and operated in a manner that meets the family needs.

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