*There are so many different types of trusts. Which one to get into if you are property wins? Perhaps a high level knowledge of these trusts can shed some light? But, be careful as usual – contact an accountant (or us) before doing anything dangerous.
Important Differences from Other Trusts
Things you should know about Family trusts?
Discretionary trusts (or Family trusts) are a popular in Australia. Close to a million of them are used for various purposes such as asset protection, tax planning, and wealth management. While discretionary trusts offer unique benefits, it’s super important to understand how they differ from other types of trusts. This article explores the key differences between family trusts and other common trust structures in Australia, including fixed trusts, unit trusts, and bare trusts. So hang in there, don’t fall asleep & keep reading!
1. Discretionary Trusts
Let’s start with the one you are probably after. A discretionary trust, sometimes referred to as a family trust, provides the trustee with the discretion to decide how the trust’s income and capital are distributed among the beneficiaries. This flexibility is one of the main features that distinguish discretionary trusts from other types of trusts.
Key Features
- Trustee Discretion: The trustee has the authority to determine the distribution of income and capital among the beneficiaries.
- Beneficiary Entitlements: Beneficiaries do not have fixed entitlements to the trust’s assets. Instead, distributions are made at the trustee’s discretion.
- Flexibility: This type of trust offers significant flexibility in managing and distributing assets based on the beneficiaries’ needs and circumstances.
According to Ford and Lee, “The discretionary trust’s defining feature is the trustee’s discretion in making distributions, which provides flexibility in responding to beneficiaries’ changing needs” (Ford and Lee 123).
2. Fixed Trusts
In a fixed trust, things are different. The beneficiaries’ entitlements to the trust’s income and capital are determined ahead of time and fixed. Unlike discretionary trusts, the trustee has no discretion in how distributions are made. Great to build trust among the beneficiaries involved – as the trustee can’t bypass or rip them off.
Key Features
- Fixed Entitlements: Beneficiaries have a fixed entitlement to the trust’s income and capital. The trust deed specifies the exact share each beneficiary is entitled to receive.
- Predictability: Fixed trusts provide predictability and certainty for beneficiaries, as their entitlements are clearly defined.
- Limited Flexibility: The trustee has no discretion in making distributions, which can be a limitation if the beneficiaries’ circumstances change.
Lewin on Trusts notes, “Fixed trusts provide certainty and predictability for beneficiaries, but lack the flexibility of discretionary trusts in adapting to changing needs” (Lewin 89).
3. Unit Trusts
Unit trusts are commonly used for investment purposes, particularly in the context of managed investment schemes. In a unit trust, beneficiaries hold units, similar to shares in a company, and their entitlements are proportional to the number of units they hold. Not all unit trusts will be fixed trusts – although I have not seen that yet.
Key Features
- Unit Holdings: Beneficiaries, known as unit holders, have entitlements based on their unit holdings. Each unit represents a fixed portion of the trust’s income and capital.
- Transferability: Units can be bought and sold, providing liquidity and flexibility for investors.
- Management and Control: The trust is typically managed by a trustee or a manager, who is responsible for the day-to-day operations and investment decisions.
Waters explains, “Unit trusts offer a flexible investment vehicle, allowing unit holders to buy and sell units and providing a proportional entitlement to the trust’s assets” (Waters 67).
4. Bare Trusts
Bare trusts live in caves, eat honey and have been known to attack humans? No, those are bear trusts! All dull accounting jokes aside, bare trusts are known as simple trusts. There the trustee holds the trust assets on behalf of the beneficiary, who has an immediate and absolute right to both the income and capital of the trust. The trustee’s role is largely administrative.
Key Features
- Absolute Entitlement: Beneficiaries have an immediate and absolute right to the trust’s assets. The trustee has no discretion in making distributions.
- Simplicity: Bare trusts are straightforward and simple to administer, as the trustee’s duties are limited to holding and transferring the assets according to the beneficiary’s instructions.
- Tax Implications: Income from the trust is taxed directly in the hands of the beneficiary, rather than the trustee.
According to Ford and Lee, “Bare trusts are simple structures where the trustee holds assets on behalf of a beneficiary with an absolute entitlement, providing clarity and straightforward administration” (Ford and Lee 78).
5. Hybrid Trusts
Many find this one fascinating – because they don’t know its limitations. We have an entire article on it. Hybrid trusts combine features of both discretionary and unit trusts. They allow for a mix of fixed entitlements and discretionary distributions, providing a blend of flexibility and predictability.
Key Features
- Mixed Entitlements: Some beneficiaries may have fixed entitlements, while others receive distributions at the trustee’s discretion.
- Flexibility: Hybrid trusts offer flexibility in managing and distributing assets, accommodating both fixed and discretionary elements.
- Complexity: These trusts can be more complex to establish and administer due to the combination of fixed and discretionary features.
Lewin states, “Hybrid trusts offer a unique blend of features, combining the predictability of fixed entitlements with the flexibility of discretionary distributions” (Lewin 134).
6. Testamentary Trusts
Testamentary trusts are established through a will and come into effect upon the death of the testator. They are often used to manage and distribute the deceased’s estate according to their wishes.
Key Features
- Establishment: Testamentary trusts are created by a will and take effect upon the testator’s death.
- Estate Planning: These trusts are commonly used in estate planning to manage the distribution of the deceased’s assets, protect beneficiaries, and provide for minors or individuals with special needs.
- Tax Benefits: Testamentary trusts may offer tax advantages, such as the ability to split income among beneficiaries who may be taxed at lower rates.
Waters notes, “Testamentary trusts are a powerful tool in estate planning, providing flexibility and protection for beneficiaries, particularly minors and those with special needs” (Waters 112).
Legal and Tax Implications
Understanding the legal and tax implications of different trust types is essential for effective trust management.
Legal Considerations
- Trust Deed: The trust deed is the foundational document that outlines the terms and conditions of the trust. It must comply with relevant laws and clearly define the roles and responsibilities of the trustee and beneficiaries.
- Trustee Duties: Trustees have fiduciary duties to act in the best interests of the beneficiaries, manage the trust assets prudently, and ensure compliance with the trust deed and applicable laws.
Tax Considerations
- Income Tax: The tax treatment of trust income varies depending on the type of trust and the distribution of income to beneficiaries.
- Capital Gains Tax (CGT): Trusts are subject to CGT on the disposal of assets. Certain trusts, such as testamentary trusts, may have specific tax advantages.
- Stamp Duty: The transfer of property into or out of a trust may attract stamp duty, depending on the jurisdiction and the type of trust.
According to Rowland, “Effective management of trust structures requires a thorough understanding of the legal and tax implications, ensuring compliance and optimization of benefits for beneficiaries” (Rowland 145).
What to think of all these?
Discretionary trusts offer significant flexibility and benefits. That is true. That makes them a popular choice for estate planning and asset management in Australia. However, it is crucial to understand how they differ from other types of trusts, such as fixed trusts, unit trusts, bare trusts, hybrid trusts, and testamentary trusts. Each type of trust has unique features, advantages, and limitations. The choice of trust structure should be based on the specific needs and objectives of the settlor and beneficiaries, even the trustee in some instances. By understanding these differences and navigating the legal and tax implications, individuals can optimize the benefits of trust structures and effectively manage and protect their assets. The only way through all that is via a good accountant. If you are looking for one, we are here to assist.
Bibliography
Ford, H.A.J., and Lee, W.A. Principles of the Law of Trusts. 4th ed., Thomson Reuters, 2017.
Lewin, Thomas. Lewin on Trusts. 19th ed., Sweet & Maxwell, 2015.
Rowland, Peter. Australian Trust Law: A Practical Guide. 3rd ed., LexisNexis Butterworths, 2016.
Waters, Donovan W.M. Waters’ Law of Trusts in Canada. 4th ed., Carswell, 2012.