Trusts are powerful tools in tax and financial management, offering flexibility and control in managing assets, tax planning, protecting wealth and planning for the future. However, choosing the right type of trust can be daunting, especially with so many options available in Australia. This guide will help explain trusts and clarify which suits your personal or business needs best.

What is a Trust?

A trust is a legal, or more specifically an equitable arrangement, where one person or entity (the trustee) holds assets on behalf of another (the beneficiary). Despite common misconceptions, a trust is not a separate legal entity like a company. Instead, it’s a relationship or a promise and is most commonly controlled by a trust deed, outlining how the assets are to be managed and distributed. Interestingly a trust can be created by actions and verbal instructions alone without any paperwork however in the tax world we most often deal with trusts created by documents.

Trusts are used for various purposes including running businesses, managing investments, protecting assets for vulnerable individuals and planning estates. As a secondary consideration, there are also tax benefits when used and structured correctly but it’s important to get the setup right.

For more detailed information about trust structures and obligations, you can refer to the Australian Taxation Office (ATO) website.

Why Choose a Trust?

Trusts are a popular choice for both individuals and businesses because they offer:

  • Asset Protection: Safeguard your wealth from potential creditors or legal claims.
  • Tax Efficiency: Distribute income and capital in a tax-effective way.
  • Wealth Management: Ensure assets are preserved and managed according to your wishes.
  • Succession Planning: Control how your wealth is passed on to future generations. Keep in mind that assets within a trust are not covered by your Will. Specific attention must be given to who will or may control the trust upon your death.

Types of Trusts in Australia

Familiarising yourself with the various types of trusts available can empower you to choose the one that best suits your needs.

1. Discretionary Trusts (Family Trusts)

Due to their high flexibility, discretionary trusts, often referred to as family trusts, are the most common type of trust in Australia. The trustee has the choice to determine how income and capital are distributed among beneficiaries. These trusts are primarily used by families for tax planning and asset management, as they allow income to be distributed to members in lower tax brackets, offering significant tax benefits—provided the complex tax rules governing trusts are carefully followed. Failure to manage the trust correctly can result in unexpected tax outcomes. Once a family trust has been correctly established only the family group will be able to benefit. Distributions to non-family members will incur significant tax at punitive rates.

2. Fixed Trusts

In a fixed trust, beneficiaries have fixed entitlements to the trust’s income and capital as specified in the trust deed. This structure is ideal for situations where clear and predetermined asset distribution is required, such as business partnerships or joint investments. A common example of a fixed trust is a basic will or estate, where assets are distributed according to fixed instructions outlined in the trust deed.

3. Unit Trusts

Unit trusts operate similarly to fixed trusts, with beneficiaries holding units that represent their share of the trust’s assets. This structure is popular for joint ventures and investment proposals, as units can be transferred or sold, offering greater flexibility in ownership. However, unlike discretionary trusts, unit trusts do not provide flexibility in distributions. They do, however, allow multiple families to enjoy some benefits of the trust structure without the family group restrictions typically associated with discretionary trusts

4. Hybrid Trusts

Hybrid trusts combine features of discretionary and fixed trusts. They offer flexibility in distributing income at the trustee’s discretion while maintaining fixed entitlements for capital. This makes them suitable for families or groups pooling resources for business projects. Hybrid trusts are generally only seen in widely held, large-scale and often listed arrangements.

5. Testamentary Trusts

Testamentary trusts are established through a will and take effect upon the death of the trustor. These trusts are designed to protect assets and provide for dependants, often with specific instructions on how and when the assets should be distributed.

6. Charitable Trusts

Charitable trusts are created to fund philanthropic causes. These trusts are tax-effective and must follow strict regulations to ensure funds are used for their intended charitable purposes. They’re ideal for individuals or organisations looking to make a lasting social impact.

7. Special Disability Trusts

Special disability trusts are designed to support the care and accommodation needs of family members with severe disabilities. They provide financial security for the beneficiary while allowing contributors to benefit from social security concessions. While these trusts sound useful often the reality is they are not as useful or as tax effective as perhaps the original intent was.

8. Superannuation Trusts

In Australia, superannuation funds operate under a trust structure. These funds manage retirement savings, offering tax advantages and ensuring financial security in retirement. Self-Managed Superannuation Funds (SMSFs) provide individuals with greater control over their investments.

9. Bare Trusts

Bare trusts are simple structures where the trustee holds assets on behalf of a beneficiary who has full control over them. These trusts are often used for temporary purposes, such as holding property for minors until they reach legal age.

How to Choose the Right Trust

Selecting the right trust depends on your goals and circumstances. Consider the following questions:

  • What do you want to achieve? (e.g., asset protection, tax planning, estate management)
  • Who will benefit from the trust? (e.g., family, business partners, charitable organisations)
  • How much flexibility do you need? (e.g., fixed entitlements vs. discretionary distributions)
  • What are the legal and tax implications?

Engaging a tax accountant and financial advisor is important to ensure the trust is tailored to your needs and complies with Australian laws. At Carbon, our team of tax and accounting experts can guide you through the decision-making process.

Common Pitfalls to Avoid

Selecting a trust as your business structure is a significant decision so it’s important to do your research and explore other options. Trusts aren’t the only structure available—you might find that a sole trader, partnership, company or joint venture better aligns with your needs. Each structure offers unique advantages and legal, tax and compliance obligations.

To assist you in making the right choice, research all available options and speak to an accountant.

Other common pitfalls to avoid include:

  • Lack of Professional Advice: Setting up a trust without expert input can lead to costly mistakes. “Off the shelf” deeds will not always be fit for your purpose and should be reviewed carefully to see if any customisations are needed.
  • Choosing the Wrong Type of Trust: Misaligned structures can limit flexibility or expose assets to risks. Consideration of the types of activities and assets the trust will be involved in is very important. The wrong trust structure may lock in inflexibilities and cash flow issues.
  • Non-Compliance: Trusts come with strict legal and tax obligations. Failing to meet these can result in penalties. These can be significant and the ATO’s power of review can be unlimited in some circumstances.
  • Working Capital: Trusts must distribute their taxable income every year this can pose problems with the accumulation of working capital as the beneficiaries must pay tax on funds they may not receive immediately if funds are retained.

Finding the Right Trust for Your Needs

At Carbon, we specialise in creating tailored solutions to suit your unique circumstances, whether you’re securing family wealth, planning your estate or managing business assets. Our team provides personalised advice, ongoing support and comprehensive services spanning accounting, tax and financial planning. To ensure a holistic approach, we can also connect you with other professional advisors, including lawyers.

Let us simplify the process and empower you to make informed decisions that protect your wealth and achieve your goals. Contact Carbon today to schedule a consultation with our trust experts and discover the perfect solution for your needs.