Family Trusts: Benefits and Disadvantages You Need to Know

Family trusts are often praised for their tax and asset protection benefits. One of the biggest attractions is the ability to split income among family members, helping reduce the overall tax burden compared to when one person earns all the income or when the trust itself is taxed.

Like a company, a family trust also provides a layer of asset protection, shielding wealth from creditors or potential claims – such as when a child marries and receives property or financial assistance to purchase a home.

Even though a home owned by a family trust does not qualify for the CGT main residence exemption, other non-tax advantages can outweigh this drawback. For example, a trust can play a vital role in business succession planning, such as keeping farmland in the family for future generations.

The Advantages of a Family Trust

• Tax planning flexibility – income can be distributed to beneficiaries in a way that minimises overall tax.
• Asset protection – helps safeguard family wealth from creditors or disputes.
• Succession planning – allows assets like farms or businesses to pass through generations.

However, these benefits are most effective when the trust holds income-generating assets. It’s not suitable for personal services income, and it works best when used for investments or business assets.

The Disadvantages of a Family Trust

While the benefits are clear, there are important drawbacks and complexities to keep in mind:

1. Complex streaming rules – If you want to distribute capital gains or franked dividends to specific beneficiaries, the trust deed must allow it, and strict rules must be followed. Getting it wrong can result in an unfavourable tax outcome.
2. Capital losses stay in the trust – Unlike a partnership, a family trust cannot pass losses on to beneficiaries. Losses remain locked in the trust and can only offset future income if certain tests (like the family trust election) are met – often limiting who can receive distributions.
3. Children’s distributions are not tax-effective – Income distributed to minors is usually taxed at penalty rates, often close to the top marginal rate, with only a small tax-free threshold (around $700).
4. Trusts have a lifespan – Most family trusts must be wound up within 80 years, and this can trigger significant capital gains tax liabilities when assets are distributed.
5. Div 7A risks with unpaid entitlements – A current High Court case may confirm that companies face tax under Division 7A for unpaid present entitlements from trusts. This is a critical issue for those using trusts in business structures.

Should You Use a Family Trust?

Deciding whether a family trust is right for you isn’t always straightforward. The benefits – such as tax savings, succession planning, and asset protection – can be significant, but so are the potential pitfalls.

If you’re considering setting up a trust, or if your current structure might need updating, it’s important to get professional advice tailored to your circumstances.

Your family’s wealth and future planning deserve careful consideration – a family trust can be powerful, but only when used wisely.