Australian family trusts are frequently used to manage wealth, protect assets, and develop tax effectiveness for small businesses and families. Of these, the most popular structure is the discretionary family trust. It is most highly regarded by those families who seek flexibility regarding how the income is distributed among beneficiaries.

This e-book explains what a discretionary family trust is, how it works in Australia, and the pros and cons, as well as giving answers to some of the most common questions so you can make a decision based on knowledge about whether it’s the best structure for your situation.

What Is a Discretionary Family Trust?

A discretionary family trust is a legal agreement whereby a trustee keeps property for the benefit of family members, or beneficiaries. Unlike a fixed trust, where amounts are indeed owing to beneficiaries, a discretionary trust keeps it up to the trustee to decide how income and capital are distributed each year.

For example, if a trust gets $50,000 in income, the trustee can decide to give different amounts to relatives depending on their tax situations and requirements.

Key Positions in a Discretionary Family Trust

  • Settlor – The person who creates the trust and puts an initial amount (usually a nominal value).
  • Trustee – The individual or company that deals with the trust assets and decides on distributions.
  • Appointor – The person who may appoint or revoke trustees, at times holding final control.
  • Beneficiaries – The family or related individuals who may be the potential beneficiaries of distributions.

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How a Discretionary Family Trust Works in Australia

  1. A trust deed is created that outlines the rules of the trust.
  2. The settlor contributes a nominal amount to officially establish the trust.
  3. Assets, investments, or business interests are placed in the trust.
  4. The trustee decides the distribution of income to beneficiaries annually.
  5. Beneficiaries do not have rights automatically; they only receive benefits at the discretion of the trustee.

Advantages of a Discretionary Family Trust

  • Tax planning flexibility – Trustees can distribute income to beneficiaries with lower tax rates and, therefore, reduce the family tax.
  • Asset protection – Assets of the trust are normally protected from creditors of individual beneficiaries.
  • Advantages of estate planning – A trust helps to preserve family wealth generation to generation.
  • Support for relatives – Income can be paid to benefit children, retirees, or other members of the family when the need arises.
  • Business succession planning – Suitable for a family business to address ownership and distributions.

Disadvantages of a Discretionary Family Trust

  • Expenses and continuing fees – Setting up a trust deed and adhering to it incurs legal and accounting fees.
  • Sophisticated rules – Trusts are subject to trust law and tax law and are thus more complex than ownership by an individual.
  • Undistributed income penalty – Undistributed income in an Australian trust is penalised at the top marginal tax rate (47% at present).
  • No automatic rights for beneficiaries – Beneficiaries do not have the right to insist on distributions, as this is in the discretion of the trustee.

Taxation of a Discretionary Family Trust in Australia

The Australian Taxation Office (ATO) views a discretionary trust as a separate entity for taxation purposes but considers income to be normally taxed in the hands of beneficiaries at distribution. Key points are:

  • Distributions to adults – Taxed at the beneficiary’s marginal tax rate.
  • Distributions to minors – Normally taxed at penalty tax unless special provisions are made.
  • Undistributed income – Taxed at the top marginal tax rate of 47%.
  • Capital gains and franking credits – May be passed to beneficiaries if invested wisely.

Is a Discretionary Family Trust Right for You?

A discretionary family trust may be suitable if you:

  • Run a family business and have the need to protect assets.
  • Have investment properties or shares and want to effectively split income.
  • Want to preserve family wealth for future generations.
  • Need the flexibility to support children or other dependants.

But perhaps not if your situation is uncomplicated and does not entail recurring administrative costs or compliance.

FAQs on Discretionary Family Trusts in Australia

1. What is the main purpose of a discretionary family trust?
 Its main purpose is to achieve flexibility in the passing on of income and assets amongst members of the family, and safe guarding family wealth.

2. Who operates the trust?
 The trustee manages the trust, yet the appointor has the ultimate say because they can dismiss trustees.

3. Is trust income taxed in Australia?
 The income is generally taxed in the hands of the beneficiaries at their marginal rate of taxation. If the income is not paid out, then it is taxed at the top marginal rate.

4. Can a discretionary trust conduct business?
 Yes. Some Australian family businesses are owned and controlled by discretionary trusts as a way of sharing profits tax-effectively and managing risk.

5. Do beneficiaries automatically have rights to income?
 No. The beneficiaries only have access to the income if the trustee chooses to distribute it to them.

6. How long can an Australian discretionary trust last?
 The standard discretionary trust lasts 80 years according to Australian law.

An Australian discretionary family trust is a powerful tool for managing family wealth, asset protection, and planning for the future. Its provision for dividing income and assets in an adaptable way makes it attractive to the majority of families and businesses. However, given the cost, compliance, and taxation environments, one should advise professionally prior to setting one up.