How To Set Up a Discretionary Trust

A Discretionary Trust (also referred to as a Family Trust) is one of the most popular types of Trusts in Australia.

It's worth taking the time to learn more about how a Discretionary Trust works. Because beyond just providing for trust beneficiaries, this legal structure could have advantages for your own personal circumstances, financial situation and estate planning needs.

Read on to find everything you need to know on setting up a discretionary trust deed. From when you need to engage professional services, how business structure and tax obligations fit into the picture, and the person responsible for holding assets.

What are Discretionary Trusts?

Chances are that you've heard the term “Discretionary Trust” or “Family Trusts” and wondered what all the buzz is about. Trusts are not only for the very wealthy, or for those who understand the loopholes in our legal system. In fact, they're used by lots of ordinary businesses and families in Australia. For a wide breadth of the income distribution, family trusts are important tool for achieving some - or all - of the following goals:

• Maximising income from certain types of investments (such as shares)

• Asset protection; protecting business and family assets from claims by creditors

• Tax purposes & tax advantages; legally minimising tax by sharing (or “streaming”) property and income among more than one person

• Save for future generations; creating a more flexible way of saving for retirement and a future family member or their children

• Making tax efficient donations to charities or causes.

For some families, a Discretionary Trust also serves as a structure through which they can allocate financial resources to a family member who have special medical or lifestyle needs and can't provide for themselves. Trust income can be an effective legal entity to support future generations or family business.

Unlike a “Fixed Trust” or “Specific Trust” - where the Trust Deed spells out exactly who the Beneficiaries are and how the Trustee should distribute entitlements - a “Discretionary Trust” is more flexible in regard to how an individuals's assets are used once they become trust assets. Under this trust deed, the Beneficiary and trust fund payouts are at the trustees discretion. Unlike a fixed entitlement, this can create complete discretion for how an individual's assets within the family trust are allocated.

The ATO refers to Trusts as “a defining feature of the Australian economy” and has estimated that by 2022 there will be over 1 million Trusts in Australia. It's clear that Discretionary Trusts make up a huge proportion of that number due to their popularity for business, investment and estate planning.

Who Should Use a Discretionary Trust?

Just like Wills, Discretionary Trusts are a way of managing and distributing family wealth (you can also set up a Trust as part of your Will - this is known as a Testamentary Trust).

An important factor which distinguishes Discretionary Trusts, however, is that they operate while key family members are living and can have a say in how they're managed.

Here are some of the top reasons why you should consider a Discretionary Trust:

• A Discretionary Trust provides an effective way to operate a business. The Trust structure offers unique protection because trust property and assets are legally owned by the Trustee, rather than the business owner(s). Subject to some exceptions, assets in the trust fund can therefore be shielded from creditors if the business fails or takes a turn for the worse. Many family businesses and SMEs in Australia opt for setting up a trust for this reason. A Discretionary Trust is a popular choice, as it offers more flexibility rather than a fixed amount decided when setting up a trust. For these types of Trusts, the term “Discretionary Trading Trust” is also often used.

• A Discretionary Trust can be a more tax effective way of acquiring and managing investments. When held for more than 12 months, for example, income from shares and unit trust fund investments can qualify for significant capital gains tax savings when they are sold.

• Discretionary Trusts are a tool for lowering tax liability in families where the majority of the income is earned by one person. In these situations tax can be minimised by distributing the income between two or more adult family members. In reducing assessable income for each individual, this again represents a legal tax strategy which motivates many individuals to set up a trust.

• Discretionary Trusts are suitable for growing families because you're not required to individually specify the Beneficiaries of the trust when it is created. Instead, flexible discretionary trust structure allows you to create a “class” of Beneficiaries, which could include any children born into a family after the Trust is set up. In terms of tax optimisation, families with adult children will benefit more from a Discretionary Trust because there are negative tax consequences when distributing income to children under the age of 18.

• Discretionary Trusts offer more retirement savings flexibility than regular superannuation. Unlike superannuation funds, there is no limit to what you can contribute to a Discretionary Trust or restrictions on where you can invest your money. And even more importantly, you can withdraw from a Trust whenever you need to.

assets to consider keeping away from a trust fund

Despite the many benefits, however, there are some situations where a Discretionary or Family Trust is not the better option for investing or holding property. One example is that there is no land tax threshold exemption for Discretionary Trusts and real estate can sometimes be held in a more tax effective way outside of a Trust structure.

Seeking the advice of a legal, financial or tax advisor will help you work out whether a Discretionary Trust is a good fit for you and your family.

How Do You Set Up a Discretionary Trust?

Setting up a Discretionary Trust involves a number of considerations, from identifying who is to benefit from and manage the Trust, through to making sure all the legal and administrative requirements are in place in order for the Trust to become fully operational. As always, seeking expert advice is the way to go.

In simple terms, these are the key things you need to do to get a Discretionary Trust up and running:

Step 1: Decide what the Trust's assets will be

Work out which property and assets you want the Trust to deal with and what the value of those assets are. Asset protection is a key benefit of setting up a trust fund, so it's important to cover the right ones with the assets held in your trust.

Step 2: Appoint a Trustee and identify the Beneficiaries

With Discretionary Trusts, the Trustee can be an individual, a company controlled by members of the family group or even a specialist third party Trustee company.

What's most important is that you choose an honest and independent Trustee with the necessary skills to effectively manage all of the Trust's affairs.

You will also need to make a list of who you want to benefit from the Trust (the Beneficiaries), and in what amounts or percentages.

Step 3: Create a Trust Deed

The Deed for a Discretionary Trust should be drafted with help from a professional. It needs to contain the following basic specifications:

• The Trust fund objectives

• What the original assets are

• The list of Beneficiaries and methods of payment

• How the day-to-day administration of the Trust should be carried out.

Step 4: Complete the administrative requirements for a working Trust

• Sign and date the Trust and find out if you need to pay any stamp duty on it in your state or territory

• Register the Trust as a business by applying for an Australian Business Number (ABN) and Tax File Number (TFN)

• Open a bank account in the Trustee's name.

Once a bank account has been opened, someone acting as a “settlor” (a friend, associate or advisor who is not a Beneficiary) must deposit the first “settlement sum” in the account to make the Trust operational.

After a Discretionary Trust starts operating, further contributions can be made and it can start to borrow, make investments and undertake a range of other functions for capital gains tax purposes

To Wrap Up

A Discretionary Trust is another important way to secure your family's future through estate planning. Although it involves an investment of time and effort and calls for professional advice, it can be a perfect solution for many families. Allowing them to protect trust property and assets, minimise tax, and more flexibly plan their financial affairs and net income.

With this in mind, capital gains from trust funds are not just for the super rich. A family trust has a range of benefits for a person's assets on asset protection and tax reasons, as well as peace of mind.

Thinking about getting started with Wills and estate planning? Start smart with Safewill. Our team of legal experts can help you in setting up a trust today- with an easy, flexible and affordable service tailored to your needs. Reach out today on 1300 942 586, or start a live chat now, to find out more.