Family trusts as an alternative to superannuation
The government’s ongoing tinkering with superannuation has seen more people considering alternative options for their retirement savings, including family trusts.
There are many good reasons for setting up a family trust, irrespective of any concerns or limits to do with superannuation. Family trusts provide tremendous flexibility for managing investment portfolios and family wealth. They are also a good complement to other long-term investment approaches such as superannuation.
For those wanting to invest a substantial amount into long-term investment strategies – for instance, more than $300,000 – and who have either maxed out their contributions to super or want more accessibility than super provides, a family trust can be very worthwhile. This is particularly so if there are low-income beneficiaries in the family group to whom taxable distributions can be allocated.
What is a family trust?
A family trust is a discretionary trust that has elected with the Tax Office to distribute the trust’s annual income to pre-determined family member beneficiaries. The Tax Office’s definition of family members covers parents, grandparents, siblings, children, nephews, nieces, lineal descendants, and spouses of any of these.
Any investment assets are held by a trustee, and the trustee can pass assets or trust income at their discretion to particular beneficiaries.
While the family trust itself pays no tax on earnings, beneficiaries are taxed on their share of trust income for the year, including franking and capital gains. In comparison, super funds pay tax on earnings, at a maximum of 15 percent.
Distributing income in this way can have significant tax advantages if there are family members on different marginal rates. This is because distributions don’t have to be made equally to all family member beneficiaries. The trustee has the discretion to decide which family members to distribute various income amounts to, with the general aim being to distribute income to those family members who have the lowest taxable income and who will then pay the least amount of tax.
A good time to set up a family trust is at the beginning of the wealth generation phase – usually in the late 30s or early 40s. At this stage, the wealth generation focus should be concentrated on building up the wealth in the family trust and reducing tax by distributing income among various family members.
Later on, retirement planning considerations and how to maximize both superannuation and family trusts benefits, can be developed.
While superannuation remains the most tax-advantaged investment vehicle for saving for retirement, there is no doubt that the continuous changes to the superannuation regime by successive governments is causing concern and encouraging people to consider other options outside super.
It is therefore understandable that a number of people are setting up family trusts to run in conjunction with their superannuation, particularly those who have a self managed superannuation fund (SMSF).
There was a noticeable increase in the number of family trusts set up at the time the then Gillard government reduced the cap on annual concessional contributions into superannuation. We also expect the cap on superannuation balances from 1 July 2017 to be a significant trigger for more people to set up a family trust.
A common approach is likely to be that people will put as much as they can into superannuation and then, once they reach the caps, start to direct any excess funds through to their family trust.
The fact that family trusts offer more flexibility than superannuation will also become increasingly attractive, as people begin to fear ‘what next’ when it comes to government changes to super.
Another way that family trusts are set to become more popular is through estate planning. For instance, if a couple has more than $1.6 million each in their SMSF, and one person dies, the surviving spouse won’t be able to keep all of their spouse’s super in the fund but instead will need to find somewhere else to invest it outside the superannuation system. A family trust is a logical next option.
Another reason to like family trusts is that, especially compared to superannuation, they are relatively flexible. They have no investment rules, no contribution rules and no preservation rules. They also allow personal assets, such as a boat or holiday house, to be held within the trust.
Family trusts vs SMSFs
Until a few years ago, family trusts were largely overlooked as a wealth management tool because people incorrectly believed that the benefits have been largely eroded. In addition, they are seen as overly complex and expensive, especially when compared with the better understood SMSFs.
In fact, the set-up costs for family trusts and SMSFs are broadly similar, at around $2,000 plus GST. In terms of ongoing costs, a family trust will probably be cheaper, at around $2,000 plus GST while a SMSF will cost around $3,000 plus GST, as family trusts aren’t required to be audited.
Far from being more complex, family trusts actually have far fewer restrictions and rules than SMSFs and are therefore simpler to operate.
A big attraction of SMSFs is the tax benefits that superannuation offers as well as the flexibility the funds give in managing retirement savings. But the benefits of family trusts are also considerable.
For example, in a family trust ownership of assets such as a share portfolio or holiday house can continue on uninterrupted even if a family member dies. This is because the family member doesn’t own the asset, the trust does. Consequently, the assets don’t form part of the individual’s estate. Additionally, many family trusts are multi-generational. For trusts formed in NSW, for instance, a life cycle of up to 80 years is allowed.
Basically this makes family trusts an ideal tool for inter-generational wealth transfer. SMSFs, on the other hand, must be wound up on the death of the last member, which can also raise tax issues.
Other advantages include:
- Asset protection
- No age limits to access funds
- Ability to run a business through the trust and
- Estate planning flexibility.
The asset protection advantages can be very useful. This is because individual beneficiaries do not own the assets of a family trust. Instead, they are owned by the trust and administered and controlled by the trustee of the trust. So if a family member is sued, assets held by the trust may be outside the scope of the law suit.
As long as trusts are used correctly and in the way that they are intended, they can be a very flexible and tax-effective way of boosting a family’s retirement nest egg, particularly in comparison with direct investment.
Michael Hutton, partner, wealth management – superannuation, HLB Mann Judd Sydney