Family trusts and tax savings
Australian families could save up to $8.4 billion in tax with a family trust.
Family trusts can seem like the things that only very wealthy families would bother caring about. After all, ATO data shows that in 2019–2020 there were only 741,823 discretionary trusts in Australia, when there were over 6.5 millions family households. What's more, those trusts reported over $241 billion of income.
With those statistics most people might be forgiven for thinking trusts are not worth the effort for the average family. In fact, as I'll show below, trusts can be used by the average household with a paid-off investment property or share portfolio to save more than $4000 a year. This is a saving that can be reinvested or used for other expenses.
In the simplest terms, a trust is an arrangement that allows a person or entity to hold assets on behalf of and for the benefit of a beneficiary. When we talk about family trusts, we are really talking about "discretionary trusts". These are trusts where the trustee has the discretion to distribute the income of the trust to the beneficiaries. A family's discretionary trust would then be a financial arrangement where parents would be trustees with an obligation to hold property for the benefit of all the beneficiaries (usually all the members of the family).
One reason a family might create a discretionary trust is so that the benefits of an investment property or share portfolio can be shared among the whole family for several generations. This would allow the income, losses and tax implications of the trust's assets to be shared in a way that helps the assets grow faster and benefit family members more.
An example of how to save money through a trust
A family with 2 adult children could save tax by distributing rent from an investment property or dividends from shares to family members with a lower salary, paying less tax on that income as a whole. This would leave more money to reinvest into the assets of the trust.
For this example let us take the following assumptions:
- ABS data and CoreLogic figures show that the typical family with an investment property would own a $650,000 property earning $18,569 in rental income per year.
- Finder's Consumer Sentiment Tracker shows that Aussie households that invest in shares have an average share portfolio of at least $71,917.
- The All Ordinaries index and CoreLogic data show this typical family could expect an average rental yield of 2.97% per year and an average dividend on their shares of 4.35%.
- ABS data shows the average age of parents of 2 adult children between the ages of 18 and 21 is 50 to 52. At that age the average income of the parents would be $71,500 and the average income for those children would be $11,700 and $29,900 respectively.
With those assumptions in mind, without a trust and at 2022–2023 tax rates, this family would pay $36,861 per year in tax. With a trust, the same family could distribute the rental and dividend income to the children as beneficiaries of the trust. This would mean the whole family paying $32,698 in tax – or $4,163 less. The trust achieves this by the use of the tax free threshold by family members who would not otherwise use it.
While $4,163 across 4 people might not seem like a lot, saving money at tax time can be an effective way to ease cost of living pressures and rising interest rates. A saving of $4,163 over the course of the year is approximately equal to a 100 basis point increase from the current discounted investor home loan rate of 6.98%.
With just over 2 million households owning investment properties, that amounts to a potential $8.4 billion in savings. These savings would increase as assets in the trust grow. This is especially relevant as Finder's Consumer Sentiment Tracker shows that 23% of Aussies plan to buy more shares in 2023.
It is important to note that while family trusts can be used to save on tax, the ATO has made clear that it should not be used to avoid tax by funnelling income through gifts or to people who are not normally entitled to that income. When setting up trusts, families should be aware that members should actually be paid, and the trust should not be used to divert money to meet the liabilities of other members. Family trusts should under the current tax rules be used largely to manage some assets for the long-term benefit of a family and not tax evasion.