What is a discretionary family trust, and why are Australian families in droves switching over? Whether you’re in the process of planning intergenerational wealth, wanting to protect assets, or simply need to improve your tax position, understanding how discretionary family trusts work can unlock stratospheric financial benefits—if used properly.
This Handbook dispels the mystery of discretionary family trusts in plain English: what they are, how they work, the pros and cons, and why they’ve become a hallmark of shrewd family money management in Australia.
What Is a Discretionary Family Trust?
Discretionary family trust is a legal arrangement in which a trustee acquires control and possession of property for the benefit of the beneficiaries, often in a sequence of one family. It is precisely what it is “discretionary” that the trustee can entirely determine how the trust income and capital is to be divided among the beneficiaries.
This stands in comparison to a fixed trust, where family members are entitled to determinate amounts of income and capital. No one on a discretionary family trust possesses a determinate interest. Instead, gains are remitted by the trustee as they desire—typically in terms of formal trust deed and typically at the request of the appointor or family members.
Key Terms to Understand
- Settlor:The person who creates the trust and transfers the initial amount (usually a nominal amount).
- Trustee:The legally appointed trustee of the trust and decision-maker with regard to income and asset distributions.
- Beneficiaries:The family members (and, in some cases, associated entities) who are entitled to distributions.
- Appointor:The person who can remove and appoint trustees, an act usually considered the most prominent within the trust.
- Trust Deed:The trust deed setting out the trust provisions.
How a Discretionary Family Trust Operates
Suppose that a couple sets up a discretionary family trust in order to own their investment property, business receipts, or other family assets. This is what usually happens:
- Trust Is Established:A trust deed is prepared and executed, and names the trustee, beneficiaries, and appointor.
- Assets Are Lodged:The trust is invested—this might be property, shares, cash, or even a business.
- Trustee Can Make Payments:The trustee pays the income of the trust out to whoever the trustee considers worthy.
- Tax Burdens Are Shared Out:The beneficiaries are taxed on the income they have received in their tax bands.
Because the income may be paid by the trustee to lower-taxed individuals (e.g., older children or dependants in lower tax bands), the structure could be very tax-efficient—if designed properly.
Why Use a Discretionary Family Trust?
Discretionary trusts are employed by families for numerous strategic reasons:
1. Tax Planning Flexibility
Since the trustee can distribute income to anyone annually, income may be streamed to beneficiaries of the highest marginal tax rate, which prevents family tax cost overall. It can make saving tax spectacular.
2. Asset Protection
Property of a discretionary family trust cannot legally belong to the beneficiaries. I.e., the property is usually protected from:
- Personal creditors of beneficiaries
- Bankruptcy action
- Forming relationships (though the Family Court will nevertheless take them into account when deciding property settlements)
3. Estate and Succession Planning
With a trust, control can readily pass from generation to generation. Instead of giving property outright in a will, families can transfer the trust’s control (e.g., trustee or appointor role), leaving assets in trust and avoiding thereby probate hassle.
4. Business Organization
Most family businesses are held in discretionary family trusts to allow for full tax-effective distribution and protect business assets from claims upon an individual’s personal status.
Common Applications of a Discretionary Family Trust
- To invest in investment properties
- To have a family business
- To manage share dividends
- To maintain family wealth
- To make provision for inheritance
- To distribute trust income among family members for taxation purposes
What Are the Drawbacks?
A discretionary family trust is flexible and rewarding, yet it is not suitable for all. Following are some disadvantages:
1. Setup and Ongoing Costs
Setting up a trust typically costs between $1,000 and $3,000. You’ll also need to prepare annual trust tax returns and may need an accountant to manage distributions.
2. Loss of Direct Control Over Assets
Legally, assets within a trust are not held by relatives or a trustee but relatives. Though a trustee could be a business or relative family, nevertheless, assets are nobody’s name.
3. Complexity in Compliance
Trusts are extensively regulated reporting, especially tax and distribution. Non-distribution income at the end of the financial year may be taxed at the margin top (47%).
4. Exclusion from Some Tax Concessions
Some of the tax concessions (e.g., the small business CGT concessions or the principal place of residence exemption) will not apply or need to be used cautiously in a trust.
Who are the beneficiaries?
Another advantage of a discretionary family trust is that the type of individuals who can be a beneficiary is very broad. The trust deed will generally specify who the beneficiaries are to include:
- Immediate family (spouse, children, parents)
- Extended family (in-laws, cousins, grandchildren)
- Associate parties (other trusts or family companies)
- Charities (if the deed allows for it so)
Incidentally, to be a beneficiary does not imply necessarily that the individual is automatically entitled to income. It is left to the discretion of the trustee at the end of the year to determine who receives what—and if anyone receives anything at all.
Taxation of a Discretionary Family Trust
The trust itself is not taxable (apart from where there is undistributed income). Instead, the tax income of the trust is paid out to the beneficiaries and included by them in their individual return.
Where the trustee fails to distribute the income of the trust by 30 June of a year, the amount not distributed is taxed in the trust on the highest 47% marginal rate.
Final Thoughts
So what is a discretionary family trust, then? It’s an ongoing, effective financial vehicle which allows Australian families to manage income, protect assets, and secure their future. It has real benefits—real responsibilities.
Before a discretionary family trust is established, seek the advice of a specialist estate planning solicitor or trust accountant. The structure must be put in place correctly, and it must be professionally administered to continue to comply and be effective.
