Can you get richer, stay rich or protect assets using a trust?

Fast-forward almost three years, and Ms Higgins is running ongoing legal battles with her ex-boss, former senator Linda Reynolds, whose legal team wants to gain access to whatever remains in the “protective trust” after a court found Ms Higgins defamed Ms Reynolds.

As fresh reports suggest Ms Higgins has already spent almost all of her money on legal and lifestyle costs, including a wedding and house in France that was later sold, average Australians may be scratching their heads about what a trust actually is and does.

They are often sources of confusion, seen as a tax shelter for rich people, but in reality they are a popular tool for managing and protecting businesses, assets and family wealth.

What are trusts?

Trusts are simply a vehicle or structure that holds assets such as money, shares and real estate, for the benefit of someone else.

Your superannuation sits in a large trust that is regulated by government legislation, but the most common type of trust in Australia is a discretionary trust, typically called a family trust.

The latest Australian Taxation Office figures show there are more than one million trusts registered in Australia, so they are not just for the rich.

Tiyce & Lawyers Family Law Specialists principal Michael Tiyce said trusts were “one of the commonly used methods of managing business and family structures in a tax-effective, legally protected manner”.

They were frequently used in family businesses for things such as succession planning and wealth planning, Mr Tiyce said.

Trusts also enable income from assets and investments held within them to be handed out to different family members, such as lower-income spouses or adult children.

How trusts work

Family trusts are effectively treated like a separate person, even though they are not. They are treated as their own entity for tax and other purposes, but all of the income they earn in a year must be split among beneficiaries. Capital gains can also be streamed to different beneficiaries.

The person, or company, who runs the trust is known as the trustee, and they can also be a beneficiary – but not the sole beneficiary. It is common within family trusts for trustees to also be beneficiaries, but potential conflicts of interest must be managed.

Assets held in family trusts are generally protected from creditors if one of the beneficiaries goes bankrupt. This is because that person is not the legal owner of the asset – the trust is.

Pitcher Partners private business and family advisory partner Ankit Sharma said using a discretionary trust created separation between a family and their wealth or business operations.

“A discretionary trust has traditionally been seen as providing asset protection benefits, when structured correctly,” Mr Sharma said.

Start-up costs

You will pay thousands of dollars to establish a trust, plus plenty of ongoing costs.

Mr Sharma said set-up costs could include legal help supplying the trust deed, stamp duties on trust deeds and ASIC costs for corporate trustees.

“A trust structure has ongoing costs of compliance – income tax returns, financial statements and various other minutes and resolutions – as well as the annual ASIC fee for the trustee company,” he said.

Mr Tiyce said costs depended on the nature of the trust and the advice needed.

“Some are more complicated than others and require input from financial and tax advisers, but you wouldn’t be looking at much change from a starting point of approximately $5000,” he said.

Financial adviser Helen Baker said people typically needed about $300,000 of assets inside a trust to make it financially viable, “similar to a self-managed super fund”.

“Having a trust isn’t as simple as investing personally,” Ms Baker said.

“It must be registered with its own tax file number and Australian business number, have a trust deed, and beneficiaries of each distribution must be nominated to avoid the trust being taxed at the highest tax rate.”

How trusts are taxed

Family trusts do not pay tax, provided all of their distributions are paid to one or more beneficiaries.

“Each beneficiary then pays tax at their own income tax rate,” Ms Baker said.

This meant lower-earning spouses could receive the distributions and pay less tax, she said. “A trust can be eligible for a capital gains tax discount.”

Trusts should not distribute income to children under the age of 18 because that money can be taxed at up to 66 per cent. Adult children – such as university students working part-time – can receive distributions, but you have to be careful.

“There is an opportunity to distribute income to lower-taxed family members, but they must receive the benefit of the distribution,” Mr Sharma said. “This is a complex area with significant ATO activity.”

Protecting wealth

While trusts can effectively hide your assets from other people, such as creditors in some situations, bankruptcy law and family law look through trust structures, so the wealth is not automatically protected.

Assets held in a trust are not directly assessable like personal assets, but if a bankrupt person controls the trust it could be argued that the assets effectively belonged to them. Also, if you transfer assets into your trust shortly before going bankrupt, those transfers could potentially be reversed.

Mr Tiyce warned that “it can be possible to break into a trust”.

“For example, if a trust is designed to avoid creditors, a judgment, or to defeat the proper claim of a spouse, then it would be more likely a court could intervene,” he said.

This article first appeared on The Australian as What you need to know about using trusts to grow or protect wealth