When is it worth starting a family trust ?
If family trusts are the new black, who do they best suit and do you need big assets upfront to make them worthwhile? Absolutely not, say advisers.
It's all about what your assets are likely to grow to and the tax rates of trust members years down the track when you sell investments and incur capital gains tax (CGT), says Andrew Simpson, partner with accounting firm Gunderson Briggs.
That's because capital gains can be distributed among family members to make use of all their income tax-free thresholds.
Thanks to the proposed cuts to superannuation tax concessions and contribution limits, there is renewed interest in family trusts.
Jonathan Philpot, partner in wealth management at HLB Mann Judd, says if you've got your mortgage out of the way and you've got monthly savings of about $5000 to invest, it's worth starting one. That's on top of maximising your super contributions.
"This would be with the aim of building up a family trust to at least $200,000 over the next few years," he says. "If, however, there was a lump sum of $50,000 and no further investments were likely, it would not be as cost-effective."
If yours is a household where you're pay-as-you-go employees and your savings are mostly in super, a family trust will not be as attractive.
Anne Graham, managing director of McPhail Financial Planning, says: "There is generally no benefit in a PAYG employee having their salary paid to a trust – there are look-through tests re taxation of income and therefore this is not effective. So trusts don't work for PAYG employee income, regardless of the level of income earned.
"They do work well for investment portfolios, income splitting, ownership of businesses etc."
Let's look at how a family business could make the most of a family trust structure.
Graham cites the case of Claire* and David* who are self-employed by their IT business, C&D Partners, drawing a nominal salary of $50,000 a year each.
The shares in the company are owned by their family trust – C&D Family Trust – and they are trustees. The beneficiaries of the trust are Claire and David, their children (students Natasha, 18, and Nathan, 21) and various other family members. The company makes a annual profit of $150,000, which is paid as a franked dividend to the shareholder which is the family trust.
"The income of the trust needs to be distributed otherwise it is taxed at penalty rates," explains Graham. "As the children have little or no income, we can elect to distribute income of say $60,000 each and Claire and David receive $15,000 each. All distributions carry franking credits."
Because the income is split, the overall tax payable is about $20,000 less than if Claire and David received salaries of, say, $125,000 each.
What about using a family trust to invest an inheritance?
Angela* and Fred*, 40, earn $180,000 and $40,000 respectively and have two children, 13 and 8. They've inherited $500,000, have no mortgage and want to invest the sum to spend the investment earnings on lifestyle expenses.
If they invested it in Fred's name, says Philpot, the annual income of $25,000 (assuming 5 per cent earnings) would be taxed at $8,62 (including the Medicare levy).
By investing the money through a family trust, the overall tax result for the first five years would be the same. But after that, says Philpot, their oldest child will be 18 and can become the main beneficiary, meaning tax would be $1,347 (including the low income rebate).
"A further five years on and perhaps the eldest child is now working but the second child could then be a beneficiary," says Philpot. "Finally when they both retire, they can split the income between them."