When most people think of a trust fund, the common thought is one of putting money aside for the kids to help pay for their education or to keep money secure until such time as children are ready to manage their own affairs.
The reality, however, is that a trust can be used to create wealth in many ways and is a flexible tool to manage wealth in a tax- effective way and help boost the pool of funds available for an early retirement. There are many types of trusts and which one you choose depends on many factors such as the type of investment, whether you will require a loan, marriage status and your susceptibility to being sued.
The most common type of trust is a discretionary trust, commonly known as a family trust. Basically, a family trust is a vehicle to accumulate investments with the profits distributed in the most tax-effective way. A family trust allows the trustee to use their discretion in distributing funds to the beneficiaries for tax purposes without necessarily paying the funds out, allowing profits to be retained and reinvested into the trust. How does this help create wealth? Consider the following example.
Consider a couple earning $85,000 each with two children aged 19 and 21. Both children are studying full time at university and not working.
They have a family trust and have accumulated investments in their trust over several years. This year, it has generated a profit during the year of $23,000. Because the fund is discretionary, the trustee can distribute the profits at their discretion.
If all the money was distributed to the parents, they would pay their marginal tax rate of 37 per cent income tax on the full $23,000, an additional $8510 tax in addition to what they are already paying.
Alternatively, if the trustee distributes to the two children, the tax implications would be no tax on the entire trust profits. By distributing the funds in the most tax-advantageous manner, the amount of tax the family pays is reduced from $8510 to zero.
So purely by minimising your tax, you can create wealth quicker in a family trust. If the family chooses to, instead of physically distributing the funds, the profits can be reinvested back into the trust to further create wealth. So while there are many benefits of using trusts to manage family wealth such as tax minimisation, asset protection and estate planning, trusts are also being used in association with superannuation to provide for a more flexible retirement.
While the superannuation rules continue to tinkered with, accumulating funds both in your super fund and also within your trust, provides flexibility as, unlike your superannuation fund, your trust doesn’t have any rules around when you can access the funds and can provide for an early retirement prior to gaining access to your super fund.
While trusts are one of the most flexible entities to accumulate wealth, you need to be aware of the costs or traps and advice should be sought prior to setting one up. The cost of establishing a family trust is relatively low. A trust generally can cost between $500 to $2000 in establishment fees with accounting fees varying between $500 to $2000 a year. You need to ensure you have enough funds and receive benefits that outweigh these costs to make it worthwhile.
The most common trap with trusts is around making a loss. Making a loss in a discretionary trust can’t be used to offset personal income. If you have investments like shares in your trust, if not structured correctly and a loss is made, you may also lose the benefit of any associated tax credits on dividend income.
It’s no surprise that trusts are a popular way to not only accumulate money, protect it and keep it in the family. Talk to your financial adviser about the suitability of a trust for your family and start gaining the benefits that many Australians are already enjoying.