Setting up a family trust could literally save you thousands a year, every year on your investment earnings. If you haven’t got one, you may be missing out. Read on and you can work out if it’s worth it for you, how much you can save and how to go about setting up your family trust. This has an Australian focus but I presume the same principles apply elsewhere in the world. But for starters…
What is a Family Trust?
A family trust is a legal arrangement in which a trustee/s (usually you and/or your spouse) looks after money in trust for certain beneficiaries (your family). You can designate a trust as either a normal discretionary trust in which anyone can be a beneficiary or if you elect them to be a family trust (by making a simple minute and ticking the box on your trust tax return), only family members can be a beneficiary of the trusts income. Family is a very broad term that includes everyone in your wider family. You can also distribute income to charities and religious bodies (eg churches).
Family trust cost between $100-$700 to set up (depending who you get to do it and which state you live in – NSW charge a $500 fee whereas most states like QLD charge nothing, see here for details). When setting up a family trust, either get your solicitor to fix you up or use cheaper online legal services.
Trust Documents here at Law Central
How Family Trusts Work?
Once you’ve finished setting up your family trust, go get an ABN and Tax File number for free from the Australian Business Register. Now as the trustee you can open bank accounts, share trading accounts or even buy a house with your trust. You simply lend your money to the family trust for it to invest. As trustee you manage that money to earn income for the trust. At the end of the financial year you must pay out all income to your beneficiaries. If you don’t, the ATO will tax you at the highest marginal tax rate on anything you haven’t distributed (not a good idea). So along the way, or at the end of the financial year, make sure you distribute all the income, so it zero’s out by year end.
What are the Benefits of Setting up a Family Trust?
The biggest benefit of family trusts is the ability for you to distribute income made in the trust between family members. So let’s say you make $20 000 in income from your investments. You can now distribute that income in the way that makes the best financial sense. You may give $2 000 to charity and $18 000 to your spouse to keep them under the tax threshold if they aren’t earning income elsewhere. So on your $20 000 you can potentially get away without paying tax.
You can also distribute some money to your kids under 18. In Australia, the ATO puts a limit on this of $416/child . You don’t even have to give the money to the kids, you just make a minute noting that payments made on their behalf for their benefit total above $416 (which of course they do!) and send the money to yourself. That’s all money the tax department can’t touch. It also maximizes family tax benefits by keeping your taxable income lower.
You can also give to any other family members as well, just keep in mind they have to list it as income in their personal tax returns. As circumstances change over time, each year you can decide which is the best and most financially wise way of distributing the money. This flexibility for investment income to be distributed in whatever way you want each year is by far the greatest benefit.
Passing on franking credits and capital gains for tax purposes
Let’s say you make money off of shares. You get your dividend and franking credits. The great thing about a family trust is that you can separate the dividend and the franking credits. So you could give the dividend to one family member and the franking credits to another, if you so desired. You could give away your dividend to charity while keeping the franking credits yourself. Whatever maximizes the tax benefits in the most beneficial way. Likewise you can designate who receives any capital gains and claims the 50% capital gains tax reduction if you’ve held those assets for more than 12 months. However, you can’t pass on capital losses, losses are only allowed to be counted against future capital gains the trust makes.
Giving to Churches
If you are part of a church you might gladly give 10% or more of your income to your local church or other ministries. That’s a large sum of money that is not tax deductible like giving to charities, in Australia, atleast. This is where the family trust is of real benefit. Now you can give the trust income, dividend income, etc to your church. This money is now no longer taxable income for you. Effectively, you’re giving is now tax deductible/tax free. Moreover, this money is no longer counted against you for family tax benefit payments, etc. That makes a big difference to your bottom line at the end of the year and means you have more to invest, more to give and more to save. A win for everybody, except the government (for whom I feel very sorrowful!)
Should You Consider Setting Up a Family Trust?
Now there’s no point you getting a family trust if you don’t have any money to invest. You have to have cash on the side. I think to make the savings worth it, you would want $20 000 or more to cover the set up cost, more in NSW. You will also maximize the benefits if you have a family, the bigger the better, so not really for singles (unless you give to a local church – this is the most tax beneficial way to give to a church no matter your marital status). So this is not for everyone.
What are the Downsides of Setting Up a Family Trust?
Set Up Costs
It has to be worth it to cover the initial setup costs. I calculated it took me way less than a year to cover this cost for my circumstances, yours are different. Do your math and work out what you will save. If it does make sense, make sure you are prepared to keep up with the admin.
Tax returns and Administrative Upkeep
You have to fill out a trust tax return, on paper, at the end of each year. You can download the form from the the tax department. It’s a pain the first time, but not that hard to do once you’ve followed the instructions. Now you could pay your accountant to do it, but it’s so simple that it’s not worth the cost. Just do it yourself. You also need to keep your book work up to date, so you know exactly how much to distribute. This is a good thing to do anyway, so you know exactly how much you are making. It does suck a bit of time every now and then though. So be prepared to keep up a spreadsheet with your dividend income, interest income, share purchases/sales, capital gains, etc. But that little bit of work can make a big difference over time.
Potential Savings With a Family Trust.
Here’s how setting up a family trust can save you lots. The following calculations are based on about a $250 000 investment earning dividends, franking credits and some cash in high interest accounts. I’m using what we’ve done as an example.
Scenario 1 : Distributing to Church and Kids – $4142.32/year saved.
- Distribute $416 per child. We have 4 children, so that’s $1664 that isn’t taxed at 32.5c/$. $1164 x 0.325 = $378.30 saved.
- Distribute dividend income of about $7500 to church and other christian ministries. If I had earned that money in our joint account it would have have been taxed at 32.5c for me and 19c for my partner. (0.325 x $7500)/2 + (0.19 x $7500)/2 = $1931.25 less tax paid.
- Maintain higher family benefits as that $9164 is not added to my income and reducing our payments by 0.2c/$. $9164 x0.2 =$1832.8 saved.
- I also pay less in HECS debt repayments.
- I distribute franking credits to the lowest income earner, to pay the least tax and get the most back.
- Lastly, give any remaining money to the lowest income so it’s taxed at 19c and not 32.5c.
- Total saved = $4142.35.
Scenario 2: No kids or churches or charities, distributing solely to the lowest income earner – $1237 saved per year.
- Paying the full $9164 to the lowest income earner will be taxed at 19c instead of 32.5c. Total saved 9164 x 0.135= $1237.
Depending on your circumstances, what you give to, how much you have to invest, what the lower income earner makes, etc will change the variables and the amount you are able to save. But most people with money to invest will be better off with a family trust than without one over time. So why not get going with setting up a family trust and start saving. Let up know if you have any troubles or need any questions answered.