Investing via a Family Trust - Australia

[TJEH]

I'm very new to the concept of FIRE, which I've been learning from MMM and other such sites. However it seems I'd been working towards that possible scenario for many years, as we've been living well within our means and saving well (though not investing much). It has taken MMM to make we realize that we may be much closer than I think, certainly <5 years should be possible, perhaps even sooner.

I'm planning to invest some funds in the ASX shortly. I'm trying to decide whether it's worth establishing a family trust to hold the investments so we have some flexibility over distribution of the income.

At the moment, my wife is working, with any investment income falling into the 37% tax bracket. I've taken a break from work for the time being (or perhaps forever!). If I go back in my current profession, the marginal tax rate would either be 37% or possibly 45%. I would say it's unlikely we'll both be working simultaneously, as we have two small children to look after.

The key things I can think of that would affect my decision re holding the investments in the trust are as follows.

1. How much will our investments generate? I really don't know how to forecast this yet, as I haven't established a suitable portfolio (another post on that one I think!).

2. The marginal tax rates for my wife and I over the coming years. As I mentioned above, this may change as either of us drop in or out of the workforce.

3. Years to retirement. My thoughts at this stage are that it would be best to hold the investments 50\50 once retired. Once again, I can't exactly project our retirement income but with a 50\50 split and franking credits on dividends the tax payable would likely be minimal. A trust would seem to add an unnecessary expense once retired. If the investments are held in a trust pre-retirement and I wanted to transfers the shares then I understand this would trigger a cgt, which may not be desirable.

4. The cost of establishing and maintaining the trust. I've been quoted $1000 to establish the trust and approx $1800 for administration and annual accounts.

I appreciate I don't have many answers re the future situation right now, but I'm hoping someone can help steer me towards a logical decision so that I can get these funds invested and working :)

[Murdoch]

Hi TJEH,
I think the answer to whether a trust is beneficial for your family will depend a lot on those unanswered questions you have raised.
How much will your funds generate per year?
How much is in your portfolio?
Are you or your wife in a profession where getting sued for everything is likely/possible?

If you live a truly mustachian lifestyle, and you are planning to retire with an income of 25K per year, and this is split between you and your wife, then a Trust doesn't make a lot of sense.
If you will generate much more income, and may go back to work for a while, then stop for a while, and you wife goes back to work for some time etc... and you have a large portfolio then the income distribution benefits of a trust make more sense. Income can also got the kids to further reduce tax.
I would advise crunching the numbers on your portfolio once you have the investment side planned.

1K to set up a family/discretionary trust is about right.
1.8K to do accounting each year seems high, depending on what you will have in the Trust. We have a single index fund in our Trust, so it is much cheaper than that each year. Also, it may be possible to do it yourself with the right knowledge?

Others here will understand Trusts much better than myself, but if you had a better idea of your overall numbers it would be easier to advise I think.

Good luck,
Murdoch

[Lukim]

I have had a family trust for approx 20 years.

My reason for establishing it was asset protection.  At that time, many professionals (accountants, lawyers, doctors) were using family trusts to protect their assets in case professional indemnity insurance was inadequate or failed.

I don't need it for that reason any longer but as my children are now older, it is a means of distributing some income to them in a tax effective manner (paying university fees etc).

A trust also has the advantage of being able to make immediate distributions (although they will be taxable).  Unlike a superannuation fund where the money is tied up until your preservation age. 

I currently have about $2m in assets through the trust.  The set up and admin costs you mention seem about right which is reasonable if you have substantial assets in the trust.

If I was starting out again now, I am not sure if I would use the trust. 

Think about what it is you are trying to achieve through the trust - I had a main purpose and it succeeded in that (although fortunately that was never tested in my case).

[bigchrisb]

I've had a family trust set up for a few years now.  My initial reason for doing so was partly tax/asset planning, but largely asset protection.  When I set it up, I was a significant shareholder and director of a consulting group.  The risk of litigation from a professional indemnity claim gone wrong, or indeed an employee gone feral were ones I wanted protection from.

However, it has also had tax planning benefits.  Its given me some flexibility in how to smooth income across tax years, and I've used a company beneficiary to be able to re-invest profits at company tax rates.   It is also very flexible if the income mix within my family changes - means that I don't need to trigger capital gains events to get the income into the lower taxed person's name. 

Downsides are of course the cost and hassle of running it.  For me, its been very worthwhile.

Pros:
- Asset protection (although was never tested)
- Ability to split investment income across multiple tax payers.  For example, I streamed some of the capital gains from the sale of a business to my (retired and low income) parents, rather than my own high tax bracket
-Ability to retain earnings (and franking credits) in a company beneficiary, use this to spread income across tax years
- Flexibility to changes in future arrangements (high earner changes, additional beneficiaries)
- Ability to provide financial assistance (e.g. to parents) on their tax rate, not mine.  Don't expect to need this, but may come in handy. 

Cons:
- Extra admin and costs
- Trusts seem to be in the ATO's cross hairs, so some risk about rules changing
- Getting assets into or out of the trust may be a capital gains event.  Makes it a problem for transfer of existing assets.
- Needs scale to be cost effective.

[Murdoch]

I'll add another / echo an above point: getting assets into and out of the Trust can be tricky.

We started our path with aggressive savings direct into a savings account for about 18months whilst I read and learned about investing etc...
When we were ready to start investing, we had a sizeable chunk of cash, created our trust on the 2nd of July to catch the new tax year, then invested all the cash into investments within the trust later that month. I had long before settled on the discretionary/family trust as being our vehicle going forward for some of the reasons listed.

It was simple and straightforward for us, but if we had large investments first, I may have thought twice about liquidating and repurchasing within the trust.

Just something to think about.

[bigchrisb]

Yep!  I started my trust a few years after I started investing.  I'm now stuck with stranded assets in my own name, which would be better off in the trust.  To move them there would lose $10,000's in capital gains tax.   My main hope for these is another major financial crisis, at which point there wouldn't be much of a realised capital gain!

Its a catch 22 with trusts.  For most people, you won't have enough money in the trust in the first few years to justify the costs of the structure.  By the time you have enough assets to justify it, you will be dealing with capital gains issues to move them in! 

If you have cash, or think you will invest a large sum over the medium term, I reckon trusts are worthwhile.

[deborah]

What about in specie transfers?

[bigchrisb]

What about in specie transfers?

Nice try.  Market value has to be determined and declared for in specie transfers.  Wish the rules were different, but alas, no.

[marty998]

What about in specie transfers?

Nice try.  Market value has to be determined and declared for in specie transfers.  Wish the rules were different, but alas, no.

Stamp duty is payable for Property transfers too....

[marty998]

I'm thinking of a company structure, just for my investments now.

The idea would be to have a "trading" company which owns my investments, then a holding company to own the trading company, with me as the shareholder.

Holding company can then be the shareholder/beneficiary of any subsequent companies and trusts established if my life circumstances change.

Love the income but hate being in the 37+2% tax bracket... would like to pay maximum tax 30% on investments as I have absolutely no need for the cash income now.

[TJEH]

Thanks for the responses so far, it all makes sense. As Murdoch correctly states, having the answers to my own questions would help :)

I have to admit I'm having trouble figuring our what to expect regarding returns. I have some investments now (~100k in a few individual stocks, an ETF and a few LIC's). I don't really plan on disposing of these in the immediate future. I will be investing considerably more, most likely into a combination of Aus\US\International ETF's. Haven't figured this part out exactly yet either.

I know a trust has many other useful functions, but for me, well I should say us, being my wife and (young) children, the main purpose is about tax effective distribution of the income. A secondary reason would be asset protection. Neither of us run our own business, but I suppose there is always the chance of litigation in our fields. The work arrangements for us both are a bit fluid right now, though I can see at least one of us "gainfully" employed for at least a few more years.

The whole FIRE discussion in our family is very new, and there is a lot to digest. The points around getting assets in\out of the trust seem very relevant - i.e. I don't want to neccessarily go and invest everything in our names individually at this point and then shortly after figure out a trust was the way to go. On the other hand, if we get to the point where passive income is enough to sustain us, then the costs of the trust will seem a bit excessive.

Much head scratching to do, and money burning a hole in our pockets :)

[TJEH]

If I was starting out again now, I am not sure if I would use the trust. 

Would you mind sharing the reasons?

[TJEH]

Pros:
- Asset protection (although was never tested)
- Ability to split investment income across multiple tax payers.  For example, I streamed some of the capital gains from the sale of a business to my (retired and low income) parents, rather than my own high tax bracket
-Ability to retain earnings (and franking credits) in a company beneficiary, use this to spread income across tax years
- Flexibility to changes in future arrangements (high earner changes, additional beneficiaries)
- Ability to provide financial assistance (e.g. to parents) on their tax rate, not mine.  Don't expect to need this, but may come in handy. 

Cons:
- Extra admin and costs
- Trusts seem to be in the ATO's cross hairs, so some risk about rules changing
- Getting assets into or out of the trust may be a capital gains event.  Makes it a problem for transfer of existing assets.
- Needs scale to be cost effective.

Great points bigchrisb.

Any thoughts on the scale for cost effectiveness? I have ~550K to invest now (not necessarily all in stocks), on top of my existing ~100k already invested. There is a chance to add another lump sum for some funds I hold offshore, depending on what happens with FX.

Could you elaborate on how the company beneficiary works - does this only apply when you also have a company structure in the mix?

[bigchrisb]

Economy of scale all depends on your situation. I probably spend about $2k a year on mine. I don't have any low tax beneficiaries, so the only gain is investment income I stream to the company, and I save 19% (49-30) on that. So break even for me is about $10k of income in the trust. At 5% yield, that needs $200k invested to break even. If you have a different tax rate difference, your potential for tax arbitrage may be higher or lower.

The company beneficiary can be either the same as the company trustee, or a separate company. I used a single company for both to save costs, but in hindsight would have been better off with two companies.

Sounds like you have enough assets and enough opportunity for tax arbitrage to make it stack up. Do your own research of course.

Note - significant edit - the $20k should have been $200k!  Teach me for using the forums on a phone.

[potm]

Thanks to bigchrisb's journal, I have investigated the option of setting up a trust.
I have run into the catch22 problem where, it's not beneficial until I have higher assets due to the running costs but by the time it is beneficial I'll have CGT to deal with.

Unrelated but I have also been thinking about options regarding retiring overseas to a country that doesn't tax foreign income and investing in countries which do not withold tax from dividends to foreign investors or CGT.
This means the only tax paid on a dollar of earnings would be the corporate tax paid by the company. Some countries it is quite low. Hongkong, Singapore and even the UK look like good places to invest from a tax perspective.
For example if you live in Singapore and invest in UK stocks. No CGT from buying and selling or from dividends. UK corporate tax rate is 20% so that is the total tax paid.
Compare that to being an Australian resident invested in Australian shares paying fully franked dividends. You have to pay CGT and fully franked dividends are effective taxed according to Australian income tax rates, which will depend on how much the income is.

[This_Is_My_Username]

great thread : )

[TJEH]

Thanks for your insight bigchrisb.

With my main focus of a trust being the distribution of income, I'm finding it hard to convince myself to do it. My children are both a long way from being taxed as adults, so that really only leaves my wife and I as candidates (there are no other suitable family members).

I've tried to break the notion of having a family trust down into three life stages:

1. Working (Earning)
2. Retired (Primarily living of investments, with some possible work related income)
3. Estate Planning (A nice way of saying how the assets are distributed when we die!)

So on that notion, dumping the contents of my brain as follows:

1 - Working

My thoughts are that if the income split between you and your partner is stable (prior to retirement) (and there are not other suitable beneficiaries) then a trust won't help with effective distribution of income - you would just hold the investments in the name of the person on the lowest marginal rate instead of in a trust. Of course this is not future proof. Case in point is that I've just gone from a marginal rate of 45% to 0% and my wife from 19% (on maternity leave) to 37%. This is probably the main reason a trust would work for us - we are coming to the conclusion that both of us working while bringing up two young kids is not that appealing, but we may swap in and out of the workforce.

2 - Retired
Perhaps a more compelling reason I can think of for not doing it is that when we retire, the cost of administering the trust is a bit too high to justify. We can each earn ~21k from our investments before paying any tax - without taking franking credits into account. So you could have ~1mil invested (equally between us) in stocks returning ~4% dividend (20k each) and not pay any tax. I would see us both "working" in some manner while retired, but probably not earning a great deal (though I suppose it does not take much additional income to generate a tax liability equal to the cost of administering the trust).

3 - Estate Planning

The last reason affecting my choice is for distribution of our estate....hopefully some time away! We had originally planned to setup a testamentary discretionary trust (tdt) in our wills. There are some similarities between the family trust (ft) and tdt structures, however the tdt has some compelling advantages for minors (they are treated as an adult for tax purposes, so the adult tax free threshold applies). As far as I know, the family trust does not form part of the estate, so there would be no assets for the tdt to hold when the time comes to execute the will if a ft was in place. I suppose the assets of the family trust could be transferred to the tdt but no doubt this would incur cgt.

It's fair to say I'm still sitting one the fence a bit.....happy for someone to pick this apart on the basis my thoughts\calcs are wrong!

* standard disclaimer - this is all my own research, I haven't spoken to a professional about any of it! *

[Murdoch]

TJEH, I like the way you have split the lifecycle up for Trust purposes. I wanted to comment on 2 points.

1. Both your children can receive $400ish dollars of income per financial year. Obviously not much, but if you tax rate is 40% then that is still $320ish less tax overall each year. Given accountant costs for a trust are about $1000 each year, this is a significant chuck towards covering it.

2. Even if you and your wife swap in and out of the workforce with varying tax rates, it is unlikely to occur perfectly in tune with the financial year calendar. This will make it hard to predict what your actual tax rate will be at the end of each June, and whom is best positioned to be allocated the distributions. As part of the accountant fee, they should be able to collate all your information and suggest the most effective distribution (of course it is not that hard to do yourself). As retirement looms it may be one of you cuts back more than the other, in which case it will be very effective to have distributions going to a part time spouse. Even a small tax saving annually till add up over time, and as economies of scale improve with stache growth the cost of administration will be relatively smaller.

A single discretionary/family trust is pretty easy to manage and relatively cheap for the advantages it provides, and for us the main advantages will be during our working years.

Murdoch

[TJEH]

aargh, sorry for the lack of response!

Yes, I had been ignoring the amount the children can receive, it's certainly better than nothing.

That is a very good point re timing of swapping in and out of the workforce. It seems kind of obvious now, but you are right that it may not necessarily correlate well with a tax year!

I've been working away at the following so at least I have a better picture of our situation and can then make a relatively informed decision:

- figuring out our expenses (including deciding on schools for our eldest, which can certainly have an impact!)
- putting together an investment plan
- looking at our current stash, savings rate, potential returns and SWR (to figure out roughly how long to go until FIRE is realistic)

I'm waiting on a call back from my accountant just to see how the fees ares structured and to see if there is anything I could take care of myself to cut back the fees.

I'm learning a lot along the way, I really appreciate the responses!

[Anatidae V]

Posting to follow :)