How family trusts and SMSFs work together
Family trusts have come back onto the radar of SMSFs following the recent budget announcements that limit the amount of money that can be contributed to a super fund and still receive preferential tax treatment.
Should the Senate approve the changes, from 1 July 2017 SMSF members will only be able to contribute $1.6 million to their super fund and benefit from the super system’s tax breaks, including the tax-free status of investments in an SMSF once it is in the pension phase.
Pete Pennicott, a principal and financial adviser with financial advice firm Pekada, says family trusts have been on clients’ radars ever since the budget announcements.
“Clients and our accounting partners have realised that once they can no longer contribute to super they need to be looking at another tax-effective structure. Superannuation is obviously where we'd like to hold most of clients’ assets especially as they approach preservation age. But if we can't use that, the benefits and flexibility of a family trust are good from a tax-management perspective,” says Pennicott.
How to decide upon a family trust
"It's not for everyone, but for the right client, it can mean we can create another tax-friendly environment in which to hold investments outside superannuation,” he explains.
He says this is far from a one-size-fits-all strategy. It's a case-by-case basis. It’s important to look at the costs and benefits of establishing and maintaining the structure. To justify a family trust structure, the portfolio needs to be of a reasonable size, taking into account the client’s marginal tax rate. It can be effective when there is a family group including parents, children, and other closely-related parties.
“So for example, if there are children who are studying for a masters degree but not really earning a big income, or earning at all, it’s possible to allocate $20,000 to them tax free. The broader the group the bigger the benefit,” says Pennicott.
Often family trusts work in combination with SMSFs. In this situation the SMSF will generally generate the minimum pension amount, which is in excess of their living expenses. So each year when the fund pays its annual pension payment in June, and the fund members receive a cash payment in their personal names, it’s important to be smart about what to do with these funds. Says Pennicott: “We don't want the money sitting idly doing nothing.”
For these clients, a family trust can make sense, as it’s a structure outside the super system where they can build wealth.
Given the tax benefits of the super system, it’s not often that it makes good financial sense to use a family trust structure over an SMSF, unless the client is a long way from preservation age.
“The one time we would use a family trust over an SMSF is where the client is younger. We might have a 40-year-old who is very concerned about the constant changes when it comes to super, especially with regards to the preservation age, there's a lack of certainty around when they can access their money. Our younger clients want flexibility and certainty of knowing they can access their investments if they need to,” says Pennicott.
These clients generally have a substantial amount of money, want to build their assets and want to know they can access their funds if they need to. “A lot can happen between 40 and preservation age. They're the clients for whom we would consider a family trust over an SMSF,” he adds.
Nevertheless, building wealth in the super system remains the preferred approach given the tax benefits.
“Superannuation is the best tax environment in which to hold your assets, especially once you're getting near, or are at, preservation age. That's why there are so many restrictions and caps in the super system, and there's so much discussion about super: because it remains the best tax environment in which to grow your assets,” says Pennicott.
“For those clients who are getting to the point where they might hit the proposed $1.6 million pension limit and they are accumulating too much within super, decisions need to be made. Assets must be allocated appropriately to another structure that works, and sometimes that structure will be a family trust,” he adds.