Which type of trust is right for you?

A testamentary trust is created through a Will and takes effect upon the death of the Will maker. The appointed trustee manages and distributes the assets received into the trust from the deceased’s estate, under the terms of the trust.

Uses of testamentary trusts

• Protecting beneficiaries: These trusts are particularly useful in providing for young or vulnerable beneficiaries unable to manage their own financial affairs, allowing assets to be managed by family for their benefit. Protection may further be provided for financially inexperienced beneficiaries who may be at risk of misusing inherited assets.

• Keeping assets in the family: The terms of the trust may require beneficiaries to be bloodline descendants to receive any distributions.

• Asset protection: Assets held in a testamentary trust may be shielded from creditors and provide some protection in family law disputes (depending on the circumstances). 

Advantages of testamentary trusts

• Provides tax flexibility, as testamentary trusts allow income to be distributed between beneficiaries in a tax-effective manner. There are also concessions for children under 18 years.

• Effectively providing for beneficiaries who are minors or under a legal disability.

• Ensures controlled distribution of wealth over time rather than a lump-sum inheritance.

Disadvantages of testamentary trusts

• Additional legal and administrative costs compared to a beneficiary receiving their inheritance outright.

• Ongoing compliance and management required by trustees.

• Disputes can arise between beneficiaries or between trustees and beneficiaries over distributions and the management of trust assets, which can be very costly for the trust.

A discretionary trust is created during a person’s lifetime and allows the trustee to determine how income and capital are distributed between beneficiaries. Beneficiaries have no fixed entitlement; instead, distributions are made at the trustee’s discretion.

Uses of discretionary trusts

• Family businesses: Commonly used to distribute income between family members in a tax effective way.

• Investment portfolios: Used to manage investment income and capital gains flexibly.

• Asset protection: Protects assets from claims by creditors and provides some protection in family law disputes (depending on the circumstances).

• Estate planning: Provides controlled wealth distribution across generations to preserve wealth.

Advantages of discretionary trusts

• Tax efficiencies, as income can be distributed to beneficiaries in lower tax brackets.

• Provides a level of asset protection since beneficiaries do not have a fixed entitlement to income or capital.

• Greater flexibility in responding to changes in financial and personal circumstances.

• May be eligible for small business CGT concessions and other tax benefits.

Disadvantages of discretionary trusts

• Ongoing compliance and management required by trustees.

• Trust losses cannot be passed on to beneficiaries and are trapped within the trust.

• Undistributed income is taxed at the highest marginal rate.

• Disputes can arise between beneficiaries or between trustees and beneficiaries over distributions and the management of trust assets, which can be very costly for the trust.

A unit trust divides the trust property into units, similar to shares in a company. Beneficiaries (or unitholders) hold units that determine their proportionate entitlement to trust income and capital. Not all unit trusts are fixed trusts for tax purposes.

The terms of a unit trust may allow the trustee some discretion to alter distribution, change the classes of existing or new units or modify the rules to value new units.

Uses of unit trusts

• Joint investments: Common in real estate or business ventures where multiple investors contribute capital.

• Managed investment funds: Many investment funds are structured as unit trusts.

• Business partnerships: Provides a structured way to distribute profits among multiple stakeholders.

Advantages of unit trusts

• Easier to introduce new investors or equity partners compared to companies, as units can be issued, bought and sold;

• More straightforward than a company structure while maintaining similar benefits.

• Unitholders can access CGT discounts if assets are held for over 12 months.

• Asset protection can be enhanced through a well-drafted trust deed.

• No regulatory authority like ASIC (as required for companies), reducing compliance burdens.

Disadvantages of unit trusts

• The sale of units may trigger CGT liabilities.

• Losses are trapped within the trust and cannot be distributed to unitholders.

• Units are considered assets, and the unit may be sold in the event of a unitholder’s bankruptcy or at risk to creditors.

• Aa change in unit holdings can result in CGT consequences and value shifting issues.

• Complex trust loss provisions apply, making tax compliance more difficult.

• More expensive to establish and manage than simpler business structures like sole proprietorships.

A fixed unit trust gives unit holders a fixed entitlement to income and capital, which cannot be easily changed. To be recognised as a fixed trust for tax purposes, the trust must meet stringent legal requirements, particularly with respect to the issuing of new units and altering unit entitlements.

It is important to note that since the decision in Colonial First Statement Investments Ltd v FCT (2011) 192 FCR 298, most unit trusts will not be considered ‘fixed trusts’ as defined in section 272-65 of Schedule 2F of the Income Tax Assessment Act 1936, unless the trust deed is carefully drafted, or the Commissioner exercises its discretion to treat it as a fixed trust.

Uses of fixed unit trusts

• Business arrangements: Useful for partnerships or unrelated third parties holding shared property or investments.

• Estate planning: Ensures specific beneficiaries receive predetermined benefits which cannot be altered or affected by discretion. 

Benefits of fixed unit trusts

• Can receive refunds for franking credits where the trust makes a loss.

• Easier to claim borrowing deductions and pass franking credits to beneficiaries in certain cases.

• Distributions to children under-18 may avoid the under-18 income rule.

• May receive land tax benefits in certain states.

Disadvantages of fixed unit trusts

• Potential loss of small business tax concessions if there are many unit holders.

• Cannot distribute losses to beneficiaries.

• The trustee has no discretion and must distribute all the income.

Trusts play a crucial role in asset management, taxation, and wealth distribution in Australia. The choice of trust depends on specific needs:

• testamentary trusts are ideal for estate planning, tax benefits for minors, and asset protection;

• unit trusts, including fixed trusts, provide certainty in income distribution, making them useful for business arrangements and structured investments; and

• discretionary trusts offer maximum flexibility for tax planning and asset protection.