Family trusts versus SMSFs

SMSF technical expert and columnist for The Australian newspaper
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Using family trusts has been a popular tax strategy for over 30 years.

At a technical level, family trusts are really discretionary trusts because, in most cases, these trusts’ governing rules will give the trustees complete freedom on how income and capital are distributed.

They will also typically give the trustees freedom to distribute money to a wide range of relatives of a trust’s “appointors”.

The appointors are the people who have the power to appoint the trust’s trustee and hence those who run the trust. In most family trusts, the appointor is one or more people (for example, husband and wife) and in some cases a company.

In 2010/11, the ATO says there were about 285,000 discretionary trusts (compared with about 440,000 SMSFs in the same year).

The overall advantages

There are three primary advantages in using family trusts:

  • The varied distribution of income and capital to minimise income taxes; for higher income earners, this has enabled income to be split with spouses and children who may be earning less;
  • A wide range of assets can be owned – the trustees are only limited by what’s in their trust deed; and
  • Run your business – many family trusts are used to run businesses.

Some people have also found family trusts a useful way of protecting business and personal assets from creditors, in the case of financial difficulty and even bankruptcy. The ability to achieve this objective using family trusts has been reduced because of various High Court cases.

Family trusts versus super funds

This is a good question. A solicitor of my acquaintance doesn’t like super. He acknowledges the tax concessions compared to other vehicles, like family trusts, but he detests the fact the rules change all the time and the fact his money is locked away until he retires.

It’s hard to argue with his pessimistic view, except to say that the super laws do change fairly often, but the range of tax laws are changing all the time in a wide range of areas, including family trusts.

The cons

A major disadvantage with family trusts is that all income and realised capital gains must be distributed each year to the trust’s beneficiaries, otherwise the trust will be taxed at the highest marginal tax rate. Many people get around this problem by notionally distributing income to a trust’s beneficiaries. A problem might sometimes arise, if these beneficiaries ask for the money technically given to them but never actually paid to them.

Obviously, this limitation doesn’t apply within superannuation because under tax law, the super fund’s trustee is taxed on the income and realised gains earned by the super fund.

The pros

A major advantage of family trusts, however, is that unlike super funds, money invested in these trusts can be withdrawn at any time. In other words, the money isn’t locked away until retirement.

As noted above, many family trusts are used to run businesses. While it’s not impossible for super funds to run businesses at a practical level, it’s quite difficult, because most business need some credit to run and super funds aren’t allowed to borrow money for this purpose.

If a family trust is used to run a business, then on the sale of the business, or business assets, CGT small business concessions might be available.

Family trusts can loan money to their related parties (however, there are tax restrictions on the interest rate that can be charged). Loaning super fund money to relatives is specifically prohibited.

And family trust assets can be easily loaned or used by beneficiaries or their relatives. This type of activity has been banned for super funds for over 20 years.

And something to be careful of

Finally, a note about distributing money from family trusts to super funds. Given super’s lower tax rate, many people are attracted to distributing family trust income or capital gains to super funds (they do this by making their super fund a beneficiary of the trust). The problem with this option is that any family trust money distributed to super funds will be automatically defined in the super fund as non-arm’s length income and taxed at 46.5%.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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