By Daniel Archibald | CFA
"Mr. Hadley. Do you trust your wife?" (Andy Dufresne, Shawshank Redemption).
In this all-time classic, Andy (played by Tim Robbins) offers the chief guard a way of saving on tax by making a gift to his wife. Though Mr. Hadley's response is quite colourful, the essence of the question is important to understand when managing your family finances. And within the Australian tax system there are some valid measures that we can take as families to save on tax, especially if we do trust our spouse and children (and others).
Over the past 30 years, family discretionary trusts have been used as an important means of minimising tax obligations. Furthermore, with the advent of superannuation, family super trusts (SMSFs) have also been widely used as a means of pooling super savings into the one trust. And families have been using corporate structures for family businesses for much longer than these both. Though many see these as vehicles for the wealthy, most of us at some stage might need to consider whether a family trust, SMSF or company is appropriate for our situation.
Family Discretionary Trust
What?
A family discretionary trust is a vehicle set-up to hold the assets of the family (shares, business assets, investment properties). A trustee is appointed and beneficiaries nominated (usually immediate family members). Each year, the trust must distribute all earnings made by the investments to the beneficiaries (or else it must pay tax on the earnings at the highest marginal rate of tax), but as it is a discretionary trust, the trustee can distribute earnings to beneficiaries in whatever proportion deemed appropriate.
Why?
In order to reduce the overall tax liability, earnings can be distributed first to lower income earners (whose marginal rate of tax is low), passing any surplus earnings to those on higher tax brackets. Care needs to be given when distributing income to minors as such income may be taxed at high penalty rates.
Family SMSF
What?
A family super trust (self managed super fund) is a vehicle set-up to hold the superannuation assets of the family (shares, business assets, investment properties). You can only have up to 4 members of the fund with every member required to be a trustee.
Why?
Many see family super funds as a good way in which to take greater control over their super. Instead of investing in the limited investment range offered by the average super fund, with a SMSF, the investment world becomes relatively infinite (shares, property, gold, an island off the coast of Dubai, etc). On top of that, pooling the super of up to 4 family members can further widen your investment scope. Care is required due to the high amount of requirements placed upon SMSFs and trustees.
Family Company
What?
A family company is generally set-up to manage a family business or enterprise.
Why?
The corporate structure does give greater flexibility on how to distribute business profits and can also provides asset protection in the event against unforeseen liabilities and litigation.
All of these trusts can be key structural ingredients of your wealth portfolio. Pooling resources and sharing earnings with your spouse, children, siblings or parents can help you to reduce your overall tax bill and provide greater control and flexibility with investing. But, as setting up such structures will add to your accounting bill, it is important to understand exactly how much tax savings you are likely to achieve before going down any of these paths.
Red - "Making a few friends, huh Andy?"
Andy - "I wouldn't say friends. I'm a convicted murderer who provides sound financial planning - it's a wonderful pet to have."