Although not technically accurate, it’s convenient if we view a trust as a ‘legal entity’. Just like a human or a company, a trust can own assets, has rights and obligations, can sue and be sued. There are many types of trust, each designed for a particular business, investment, asset protection and/or taxation purpose.
So, what is a trust? Commonly, they involve a written agreement (trust deed) by which a person (the settlor) provides money or property (trust assets) to a person or company (the trustee) who agrees to hold the trust asset for the benefit of the others (the beneficiaries).
Some trust deeds nominate a person to remove and replace the trustee (the appointor). The appointor is often considered the 'ultimate controller' of a trust because, although the trustee manages the business and affairs of the trust, the appointor can determine who acts as trustee. You can imagine that if an appointor wasn’t happy with the way a trustee was managing the trust, the appointor would replace the trustee with another one.
So how can you 'picture' a trust set up? it looks a lot like this:
The most common type of trust is called a ‘family trust’ or a ‘discretionary trust’. This type of trust is used to operate businesses or simply hold investments, such as properties or shares. The beneficiaries include a broad range of family members, such as grandparents, uncles, aunts, cousins, parents, siblings and children. But there are three unique feature of this type of trust
- First - no beneficiary has any right to any part of the trust assets. Each financial year the trustee determines who will receive a distribution. The trustee has an unfettered right to determine who receives and who doesn’t – thus why it’s referred to as a ‘discretionary trust’. There are many variations of this type of trust, as each is tailored to suit the circumstances of the person who created it.
- Second - The power of an appointor to remove and replace the trustee is not 'property' for the purpose of the bankruptcy act, so, as a general rule, even if the appointor becomes bankrupt the appointor can continue to determine who controls the trust and it assets without interference for a trustee in bankruptcy. As you can imagine this issue can (and does) become very complex if contested so extra special care is required if a motive for using a discretionary trust si asset protection.
- Third - The trustee can stream trust income to adult beneficiaries who have a low marginal rate of tax or to company beneficiaries to minimise the overall tax rate being paid on trust income.
Why use them?
There are asset protection and taxation benefits provided by a discretionary trust that are not available to individuals, companies or other types of trust. They also enable the passing of control of assets from one generation to the next without triggering transfer costs or the payment of taxation (no advelorum stamp duty or CGT). Details of these benefits are a little too complex to deal with in this article but, believe me, they are worth investigating.
Capital Protected Trusts
Another common form of trust is one where the trustee manages assets for the benefit of a beneficiary who is not capable of managing their own affairs because they:
- suffer a severe mental disability, or
- are dependent on drugs, alcohol or gambling, or
- are exposed to the undue influence of someone who will exploit their vulnerability, or
- for any other reason they can't manage tgheir own affairs, or
- the person who establ;ishes the trust wants the capital to be preserved for future generates.
Again there are many variations of this type of trust, with some providing an income stream to the beneficiary while others permit the trustee to provide housing and other benefits. Some are designed specifically for severally disabled beneficiaries and enable them to benefit from trust assets and income without being disadvantaged by the application of Centrelink means testing.
Why use a capital protected trust?
In this case
- it’s to ensure a vulnerable beneficiary receives appropriate financial support and other support without risking the capital in their hands, and/or
- it's to provide financial assistance to a person or family, but preserve the capital for future generations.
There are other forms of trust – such as unit trusts and hybrid trusts, which are designed for specialised business purposes – but they are less common so I haven’t dealt with them in this article.
The Pros and Cons
Trusts are ‘tools’ designed to protect assets and/or minimise taxation, among other functions. If used appropriately, they can provide enormous benefits. However, as with all tools, if they are mishandled they can cause more harm than good. If you wish to create a trust, it is critical that you obtain expert advice to determine the best option for your circumstances. Equally important is to regularly check in with your advisor to ensure that you are operating the trust correctly – it is easy to undo a well-devised trust by not following the relevant legal, accounting and taxation rules.
Lastly, assets held in trust do not form part of your estate when you pass away. This makes trusts a valuable estate planning tool, however, again management of this feature of a trust requires careful attention to ensure trust assets end up in the control of the appropriate person when you pass on. A simple issue to address, but one that is often overlooked – to the detriment of families.
The information in this article should be considered general in nature only and not relied upon. Legal advice should be sought. This information has been provided by Rod Cunich, author of Understanding wills and estate planning. Rod can be contacted via his site Rodcunichlawyer.com, where you can learn much more, and also buy a copy of his book.