Welcome to one of Australia’s most popular (albeit poorly understood) investment structures: the trust fund. A widespread misconception surrounds trusts as vehicles reserved for the very wealthy. In reality, a trust is a savvy, practical financial tool that enables even "comfortable" folk to protect a range of personal, family and business assets (see How to Set Up a Trust Fund If You're Not Rich).
Practicality and popularity aside, trust funds are often complex living entities with unique personalities and individual needs to consider. Setting one up can become a nuanced affair, so it pays (literally) to get it right.
What Is a Trust Fund?
“Trust” is an umbrella term for a variety of structures, each of which bears its own specific procedures, regulations and tax rules. In principle, a trust is a very simple concept. It’s a private legal arrangement in which the ownership of someone’s assets (which might include stocks, bonds, cash, real estate or even works of art or antiques) is transferred to the trust and held or managed by an individual (or group of individuals) for the benefit of others. The person originally providing the assets is generally referred to as the settlor. Those appointed to manage the trust – and to distribute its assigned assets – are known as trustees, while those who receive funds, property or other benefits from the trust are the beneficiaries.
Why Create a Trust?
One key reason: to get assets out of a person's estate or portfolio. Once a settlor has assigned assets to the trust, he or she no longer owns them, putting them effectively out of the reach of creditors in bankruptcy proceedings or plaintiffs in lawsuits. They can't be used to cover financial setbacks or subverted in case of a fallout amongst relatives. As such, trusts are a widely used "safe haven" arrangement for family and business assets. (For more, see Advanced Estate Planning: Using Trusts).
Other common reasons to create a trust include:
- To control and protect family assets (possibly the most popular motive)
- When someone is too young (or incapacitated) to handle their own financial affairs
- To save "spendthrifts" from themselves
- For the management and distribution of pension/retirement funds during the term of an individual’s employment
Types of Trusts
Australia recognizes a number of trusts, which generally fall into one of the following categories:
1. Family/Discretionary Trust
A Family Trust (also known as a Discretionary Trust), one of Australia’s most common small business structures, is ideal for families with private businesses and capital growth or income-generating assets. As the name implies, a Discretionary Trust provides the trustee with discretion over who receives distributions from the trust and when (in accordance with specified trust terms). A Family Trust is relatively easy to set up, simple to operate and accepted in every Australian state. Most important, Family Trusts provide a great deal of flexibility with regard to sharing the tax burden among family members, distributing income and, of course, protecting assets.
2. Unit/Fixed Trust
A Unit (or Fixed Trust) differs from a Family Trust in that generally the trustee does not have discretion over distribution of capital or income to beneficiaries (unit holders). Rather, it divides the beneficial ownership of trust property into a number of units, similar to shares. Each beneficiary (known as a unit holder) has a number of units in the trust, and at the end of each year, distribution from the trust is determined according to that number and in the manner dictated by the Trust. Unit Trusts are recommended when more than one family is involved, as they operate somewhat like a company.
3. Hybrid Trust
A Hybrid Trust bears characteristics of both Discretionary and Unit Trusts, whereby the Trustee is given power to distribute trust income and capital among nominated beneficiaries (as with Discretionary Trusts). The income and capital, however, is distributed in a proportional method (as with Unit Trusts) relative to the number of units held by each beneficiary. Hybrid Trusts are often a preferred method of structuring a business or investment activity (especially real estate) because they have income tax and capital gains tax benefits.
Establishing a Trust
Setting up a family trust is a fairly straightforward process; it can even be done online for a small fee starting at around $150 (plus Stamp Duty). Slightly more complicated structures – for example, those requiring the active management of a corporate trustee – can start around $1,200 and move upward, depending on the level of professional advice required.
Trust funds are legally binding and often complex arrangements, so obtaining adequate professional advice is strongly recommended with regard to their establishment. Here is what you, the settlor, will be required to do:
Step 1: Decide Upon Original Trust Assets
List all the holdings, along with their current value, to be placed in trust.
Step 2: Appoint Trustee(s)
Select an individual or financial institution to serve as trustee (banks are often used). Make it a place or person you trust (pun intended) because the trustee will bear significant legal authority, not to mention control, over trust assets.
Step 3: Determine Beneficiaries
Compile a list of people or entities that will be entitled to receive benefits and include the percentage of those benefits to which each is entitled.
Step 4: Draft Trust Deed
A trust deed is a legal document prescribing the rules that govern your fund, and the powers of the trustee. It includes the fund’s objectives; specifies original trust assets; identifies the beneficiaries; identifies how benefits are to be paid (either via lump sum or income stream); details how the trust may be terminated; and sets out the rules for operation of the trust bank account. Don't try this at home: While you specify the terms and conditions, the deed should actually be crafted by someone with specialized legal and financial knowledge in the establishment of trusts.
The trust deed must be:
- prepared by a qualified individual (as it is an official legal document)
- signed and dated by all trustees
- executed according to state or territory laws
- regularly reviewed and updated as required.
Step 5: Stamping
Stamp Duty (state-based) tax may be payable on the trust deed, depending on the state or territory. Stamping can be arranged directly through the relevant revenue authority or via a lawyer or accountant in your relevant state or territory.
Step 6: Register as a Business
As with other Australian business structures, you will need an ABN (Australian Business Number), TFN (Tax File Number) and a business name for the trust. Depending on the trust type and complexity, you may be required to register it as a company.
Step 7: Open a Bank Account
Once the trust has been established, a trust bank account should be opened in the trustee’s name. The bank may require personal details about the trustee(s ) – and possibly all other parties involved – before it will open the account.
Step 8: Commence Trust Activity
Once the bank account has been established, the trust becomes operational and is able to accept contributions or make investments subject to terms prescribed by the trust deed.
The Bottom Line
Trusts have become a common way of structuring financial affairs, and a logical, tax-efficient means to distribute earnings that protect wealth for future generations. However, it’s important to be crystal clear on the legal relationships and obligations associated with any trust before creating one, as they are usually irrevocable. A number of online platforms exist to streamline the setup process for a minimal fee, but advice and guidance from a lawyer, accountant and/or tax advisor is highly recommended.