How Trusts Work

What is a family trust?

A family trust is a common type of trust used to hold assets or run a family business.

Essentially, it is a relationship where a trustee holds property or assets for the benefit of a beneficiary or beneficiaries.

Trusts can benefit anyone who wants to manage their money in a way that is more tax effective and beneficial to their family.

In this article we take a closer look at family trusts, how they work, trust benefits and advantages, so that you can be informed about what the best structure is for your business.

Setting up a family trust is often driven by a new business opportunity, a growing business, or a need to better structure your investments. When set up correctly, there are clear tax benefits when it comes to operating as a family trust.


What Is an Irrevocable Trust?

Once an irrevocable trust has been set up, it becomes unchangeable. You can’t change the terms, and you also can’t cancel the trust. Specific types of irrevocable trusts have specific advantages, so it’s well worth consulting with a tax expert if you plan on using an irrevocable trust in your estate plan. The advantages that may be available when setting up your irrevocable trust include the following:

  • There are many irrevocable trusts available that can help your estate minimize or avoid estate taxes. These trusts can be quite complex, so expert help is always advisable when choosing this type of irrevocable trust.
  • If one of your beneficiaries is disabled and you’re worried that adding to their income or assets will disqualify them for government programs like Medicaid, you can set up an irrevocable trust to help provide for them without significantly impacting their ability to receive such aid.
  • An irrevocable trust provides more creditor protection than a revocable trust can, so if this is important to you or your beneficiaries, making your trust irrevocable may be the better option.

One common example of an irrevocable trust is the testamentary trust, the terms of which are outlined in your will. The testamentary trust is not created until your death. At that point, the trust comes into existence following the terms you’ve set out in your will, and once established, these terms cannot be changed.

The advantages of having a family trust

Family trusts offer several attractive financial benefits that make them popular solutions for estate planning and the protection of assets. Here are some of the key benefits:

  • Reduce taxes payable on death: An individual who holds many assets, from real estate to shares, can transfer these into a family trust to prevent their estate from having to pay exorbitant taxes after they pass away. The trust, rather than the individual, becomes the owner of the assets, meaning that any capital gains are earned by the trust as well. As a result, these gains are not taxable when the individual dies.
  • Easier wealth transfer: A trust smooths and facilitates the transfer of assets within the family after the settlor’s death. 
  • Protection of assets: A family trust holds assets on behalf of its beneficiaries, shielding them from any claims that creditors might make against individual beneficiaries. If a beneficiary loses a lawsuit, for example, assets held in the trust cannot be seized for the benefit of a third party. 
  • Protection of children: There are numerous ways for a trust to be used for the benefit of children. The specific rules are laid down when the trust is established, setting out specific ways in which wealth may be transferred to children. It could come in the form of an annuity or a donation to be managed by the trustees rather than being transferred directly into the child’s hands. In this way, a trust can be used to provide for a child who is unable to work due to a disability or to create a long-term financial benefit for grandchildren.

How to Set up a Family Trust

You can set up a trust online or through an estate planning attorney. Although setting up a trust online is cheaper, working with an attorney will be useful if you have complex financial needs.

Here are the basicsteps to set up a family trust:

  • Draft the trust document – The trust document states what assets are in your trust when you execute the trust, and who are the beneficiaries of your trust.
  • Choose a trustee – You need to decide on a trustee that you trust to manage the assets in the trust and to execute the trust document faithfully. If you have a revocable trust, you can act as the trustee yourself. 
  • Transfer assets into the trust – This includes transferring deeds, titles, and other ownership rights to the trust. If you don’t do this, the trust won’t be effective. You can place real estate, vehicles, fine art, heirlooms, bank accounts, and investment instruments into a family trust. 

Types of trusts which one is best for you?

There are two types of trusts in Canada: testamentary trusts and inter-vivos trusts. A testamentary trust is created as part of a will and comes into effect only after the testator/ settlor passes away. An inter-vivos trust is established while its creator is still alive. Which one you choose depends on what you intend to do with it. If your primary concern is to ease the transfer of assets to your heirs while ameliorating your estate’s tax burden, then a testamentary trust is probably all you need. On the other hand, if you want to use the benefits of a trust for your business and your family during your lifetime, you will want to establish an inter-vivos trust.

Benefits and Advantages of Family Trusts

Family trusts offer a variety of benefits. These advantages include:

  • Avoiding legal challenges: A family trust provides the advantage of being airtight legally as opposed to a simple will, which can be challenged. Family trusts can avoid legal challenges to asset dispersal.
  • Avoiding the probate process: This is another substantial advantage over a simple will, as the estate can avoid probate court with a family trust. Avoiding probate allows your assets to be distributed efficiently, avoiding the cost, publicity, and delay that probate court creates. Probate court can cost between 4% and 7% of an estate.
  • Limiting exposure to estate taxes : Family trusts are often part of proper estate planning since they limit potential estate taxes.
  • Limiting exposure to gift taxes: As with estate taxes, family taxes can reduce gift taxes.
  • Offering flexibility: Family trusts are very versatile, as you can adjust and amend the terms.
  • Offering simplicity: With the help of an attorney , a family trust is relatively easy to prepare and account for. Likewise, transferring asset ownership to a trust is relatively simple.
  • Offering a high degree of control: The terms of a family trust will dictate exactly what should be done with your assets if you become incapacitated or die. Trustees must strictly carry out instructions in a trust; if they do not, they will face civil suits and even criminal prosecution. By creating a family trust, you choose the conditions of how and when your assets will be distributed after your death.
  • Protecting your assets: A family trust better protects assets from creditors as well as lawsuits.

Additionally, family trusts allow you to name a successor trustee. A successor trustee will manage your trust after you die. This trustee can also manage your trust assets if you become unable to do it yourself.

Family trusts and tax returns

When set up correctly, there are clear family trust tax benefits for individuals and businesses.

Because the trust itself does not pay tax, beneficiaries are taxed based on the amount of income placed in their name (as well as any other income they may have from other sources).

A family trust allows you to distribute profit amongst family members to utilise their income tax “tax-free thresholds”.

If the business’ profits grow too large to distribute effectively, a family trust can also distribute to a separate company to cap the tax rate at 27.5 per cent.

Family Trust vs Company

One of the key differences between a trustee company and a trading company, is that the trustee company doesn’t trade, it doesn’t have its own tax file number and it doesn’t lodge a tax return of its own. It simply makes decisions for and on behalf of the family trust.

Some other important distinctions are:

  • Companies cannot access the 50% capital gains discount, whereas a family trust can. Small business capital gains tax discounts can be accessed by both.
  • A company is paying tax at 30% or 27.5% and pays tax from the first dollar. However, a family trust doesn’t pay tax and profits are pushed out each year.
  • A company can accumulate profits and reinvest those profits into the business as working capital.
  • Companies are great for doing business with unrelated parties and you will be protected by the Corporations Act. As for a trust, if a party is not within family group, you cannot bring them into the trust with you.

Family Trust Explained

If you’ve been thinking about setting up a family trust, it’s important to understand that the concept of a family trust that’s most commonly used during the estate planning process doesn’t refer to a specific, legally defined type of trust.

When people talk about a family trust, chances are they are referring to the most common meaning behind the term. In most estate planning scenarios, a family trust is simply a trust that benefits the family members of the individual who’s setting up the trust.

In trust terminology, this person is known as the grantor or settlor of the trust, while the family members who benefit from the trust are known as the beneficiaries. One other trust term is important, and that’s the trustee. This is the person you select to manage and administer the trust.

Because a family trust can be any trust vehicle where the beneficiaries are family members, the type of trust you set up when creating your family trust will depend on your particular needs.

Should you set a family trust?

That will depend on your personal circumstances. You will need to get independent legal and financial advice to determine if a family trust structure could benefit you and your family. Given the benefits, it is worth considering. However, please note that transferring your existing assets to a family trust will come with tax implications.

Advantages of family trusts

1. Tax planning

A family trust is taxed at the highest income tax rate, which is 45%. However, any trust income distributed to the beneficiaries is taxed at the income tax rate of the beneficiary who receives the distribution.

A family trust is commonly used to minimise the total income tax paid by the whole family. Generally, the trustee in a family trust distributes the trust income among the trust’s beneficiaries and allocates more distribution for a family member with a lower income tax rate than the other parties. This reduces the total amount of tax paid on the trust income by the beneficiaries.

2. Asset protection

A family trust structure can protect your family’s wealth from creditors. Usually, when a person owes money and cannot meet the repayment requirements, the creditor can access the person’s personal asset to recoup the debt payable. Personal assets include your home, car, and other property a person owns in their name. If the family trust is holding the personal assets, then the trust’s beneficiary has no legal rights over those personal properties. Therefore, the creditors of the beneficiaries cannot access them. This includes even if a beneficiary becomes bankrupt.

3. 50% capital gains tax discount

A capital gains tax is payable on any profits you make from the sale of an asset. A family trust can get a 50% discount on capital gains tax for any profit made from selling any assets the trust has held for more than 12 months.

4. Carry forward losses

A trust does not distribute any losses to the beneficiaries. This means the beneficiaries will not be called upon to contribute money to the trust to meet any loss. Instead, losses from each year can be carried forward to the following year.

Who Needs a Trust?

Bob Marley’s son Rohan holds up a set of speakers sold under the Marley family name. Ethan Miller/Getty Images News/Thinkstock

To illustrate why you might want a trust, it’s fun to look at a celebrity example. Take Bob Marley, who was married with at least 11 children — and who had no trust, or even a will, when he died in 1981. The estate was worth $30 million then and is estimated to be worth $130 million now (and this is before the deal to put the Marley name on weed) [source: Mayoras]. But fights over control of the trust and what Marley would have wanted to have done in his name have been expensive and painful for the family. Some estimate that unauthorized Marley merchandise is a $600-million-a-year business [source: Kenner].

A modern-day music icon living under U.S. (rather than Jamaican) law could take steps to avoid unforeseen problems like these. He could set up a trust to outline ownership and protect his children and their children for generations. With a trust or a series of trusts, he could have helped his heirs avoid any estate taxes upon his death. A trust would allow him to shield those assets from false creditors by making it clear who controls the assets once the superstar is gone. It could allow him to provide regular dividend payments for each family member, succession plans for any businesses the icon invested in and a growth strategy for his legacy. With it, he could dictate clearly what could or could not be done with his likeness, image and name to ensure future generations would be able to understand his values and act as he would. It could also include instructions on what his kids must achieve before they inherit a full share of the empire. It would likely help keep his business private, instead of being aired in public after his death.


Similar problems could have been avoided by the family of Michael Jackson, the family and long-time girlfriend of novelist Stieg Larsson, and the family of Lou Reed [sources: Bostwick, Mayoras].

For the average person, trusts are typically used to avoid probate. Living trusts let you transfer your house, for example, or other property that doesn’t have a beneficiary named to it already. Living trusts are like wills with built-in probate avoidance. But they can be more expensive than wills to set up and administer, so be sure to weigh the costs of establishing a living trust against the costs of probate. (Plus, if you have a living trust, you need a will, too.)

Then there are other ways to avoid probate — like holding a house in your own name and the name of your spouse or a joint tenancy with your beneficiary. Or keeping money in accounts that are payable on death or include named beneficiaries. Or keeping accurate records. All of these tactics should make probate either nonexistent or relatively easy. According to the AARP, revocable living trusts have become so widely sold to individuals who are least likely to need them that the Internal Revenue Service has flagged these trusts as a scam. The benefits being touted to sell these trusts might be misleading or inappropriate for individuals or families with modest savings and income [source: Nolo].

However, if you are a family that has substantial assets and/or complicated dynamics, a family member with special needs or a property owner in more than one state, a living or other type of trust could make sense. Whenever the legitimacy of an estate could be called into question, a trust might help sort out unnecessary disputes. Families setting up these trusts should look for experienced attorneys who understand the laws in your state. The trust instrument should be personalized, drafted to the needs of your family, instead of boilerplate. Costs should always be considered when weighing the benefits of the trust.



Setting up a family trust is not for everyone. Hopefully, you now have a better understanding of what a family trust is, and some of the benefits of setting up a family trust. If you think your family might benefit from a trust, contact an estate planning attorney to see which type of trust would best suit your needs.


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