Succession planning for family trusts

One of the more challenging issues in testamentary planning is how parents deal with assets which are held in family trusts.

Like the assets of superannuation funds, the assets held in family trusts are not beneficially owned by either of the parents, and therefore cannot be dealt with in their Wills.

Unlike superannuation funds however, there is no simple “nomination form” by which family trust assets can be successfully dealt with. The only way in which those assets can be transferred to individual beneficiaries (e.g. adult children) is by a formal distribution to beneficiaries in accordance with the relevant provisions of the trust deed. This not only requires consideration of the technical requirements of that trust deed, but can have tax (particularly, capital gains tax) and stamp duty consequences.

A brief review of how family trusts work

One of the principal attractions of family trusts as a planning vehicle during the parents’ lifetimes, is the flexibility which that structure allows in distributions of income and capital. Children, their spouses and children and associated entities can be assisted as the parents see fit.

Family trust assets are held for a wide “class” of potential beneficiaries. Because family trusts are discretionary trusts, the trustee has an absolute discretion as to which persons from the eligible class are entitled to those assets and in what proportions. The trustee is under no obligation to distribute assets until the Vesting Day, which can be up to 80 years after the establishment of the trust.

Similarly, because they are discretionary trusts, income earned on assets does not “belong” to any particular person. As with distribution of assets, the allocation of income of each year is a matter for the discretion of the trustee. The trustee can distribute some or all of the income to some or all of the beneficiaries in any amounts or proportions which it chooses, or it can decide to accumulate some or all of the income instead.

The trustee of a family trust is usually a proprietary company. Typically, that company will have two issued shares, held by one or both parents.

The decisions of the company (including any decisions which it makes as trustee of the family trust) are made by the directors. The directors are appointed by the shareholders. Typically, all shares in the company are owned by one or both parents and the board of directors comprises one or both parents. They therefore control the trustee.

Flexibility v certainty

From the parents’ perspective therefore, the combination of the flexibility of the structure and the control which they exercise over the trustee, makes the family trust an attractive entity for holding assets and dealing tax effectively with income during their lifetimes.

On the other hand, one of the principal objectives of testamentary planning is to provide certainty to surviving family members of their entitlements to family assets. In the case of assets held in family trusts therefore, the question of to whom control of the trustee will pass and what restraints, if any, are to be imposed on the exercise of that control become critical.

Distinction between passing on assets and passing on control of assets

The only “asset” which parents can leave in respect of the family trust is their ability to pass control of that trust to their children. Control is an absolute concept and cannot be fractionally divided between family members.

For example, the parents may leave the family home and their personal assets in their Wills to their 3 adult children equally. Each of the children will have an unequivocal right to a one-third share.

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