What is a trust?
A trust is not a legal person, like an individual or a company. It is a legal relationship that involves a legal owner (the trustee) holding property for the benefit of other people or entities (the beneficiaries). This relationship is established and governed by a trust deed. In all trusts, the trustee:
- holds the legal title to the trust property; and
- holds the trust property for the benefit of the beneficiaries of the trust or for a recognised legal purpose such as a charitable purpose.
For example, in the case of a family trust, often the parents or a specifically established company will act as a trustee that legally holds property for the benefit of all the family members, who are the beneficiaries.
What is a trust deed?
A trust deed is a legal document that sets out the rules on how the trust will operate. These rules outline the parties involved in the trust, the rights and obligations of those parties, and detail how procedural steps are completed (such as how to change the terms of the trust deed in future).
How does a trust work?
Usually a trust is established by a person, called the ‘settlor’, who pays an amount known as a ‘settled sum’, to a trustee. The trustee holds the sum on trust in accordance with the terms of the trust deed, for the benefit of the beneficiaries. Other assets or investments can be transferred to the trustee by the family, or acquired by the trustee.
While the trustee has legal ownership in the assets in the trust, the income and capital from the assets are distributed to the beneficiaries. Income distributed from a trust to beneficiaries is treated as the beneficiaries’ income and is taxed at their own marginal tax rate. Any remaining income not distributed is usually taxed at the top marginal rate, and treated as the trust’s income.
What are the main benefits of trusts?
Benefits of trusts include:
- Protection from creditors – as the assets are held by the trustee and not owned by the beneficiaries of the trust, the trust assets are not available to be paid to creditors of a beneficiary;
- Family law advantages – trusts can provide some protection for assets in family law disputes (depending on the circumstances); and
- Taxation benefits – including the ability to make distributions to a wide range of beneficiaries (determined by the trustee) allowing for tax effective distributions.
What types of trusts are there?
- Discretionary trust – often described as a ‘family trust’, is a trust that provides the trustee with a high degree of discretion in controlling the property held by the trust and the amount of income paid by the trust to the beneficiaries;
- Trading trust – is a trust established to hold the property of a business for the benefit of the business owners, while the trustee company operates the business;
- Unit trust – unlike a discretionary trust, the income provided to beneficiaries is set according to the number of ‘units’ they hold. It is often used in situations where funds are pooled for investments. An investment company acts as trustee and the investors, as beneficiaries, receive units in the trust. Distributions of income are then based on the number and/or type of units held by the investors; and
- Testamentary trusts – are trusts created by the terms of a Will. The estate of the deceased individual passes to a trust for the benefit of the beneficiaries. The alternative would be for the residuary estate to pass directly to the beneficiaries of the Will, however testamentary trusts provide the benefits of the trust relationship, including tax planning opportunities and asset protection.