Trusts: the different types and their benefits

Explore what a trust is, how trusts work, and the different types of trusts in Australia, from family trusts to testamentary and charitable structures.

Many of our clients have a business structure that involves a trust and whilst the common response is “sounds great” (and we appreciate that people put their trust in us) it’s worthwhile understanding what this structure actually means, and how the types of trusts differ.

What is a trust?

A trust is a legal setup where the trustee is a protector for your business or venture, and is responsible for managing it in the interests of other people, known as beneficiaries. This trustee can be a person or a company and they handle all aspects of the trust, including its finances. Trusts are often used to keep their business assets safe for the beneficiaries as they add a layer of legal protection. The trustee is the one who decides how the profits from the business or investments should be shared among the beneficiaries each financial year.

Sometimes the easiest way to wrap your head around what a trust is… is to start with what it isn’t.

What’s NOT considered a trust?

Despite sounding similar or involving legal or financial relationships, the following aren’t considered trusts:

• An unsecured debt – that’s just money owed without any security tied to it.
• An equitable charge – more of a legal interest in property, not a separate structure.
• A conditional gift – giving someone something only if they meet a condition doesn’t create a trust.
• A personal equitable obligation – where someone is morally or legally obliged to act, but it’s not in the form of a trust.
• A statutory trust – even though it has “trust” in the name, it’s created by law and operates differently.
• A Phillips trust – a term with specific legal meaning, not a true trust as we’re talking about here.
• And finally, a body corporate – a company or legal entity isn’t a trust, even if it holds assets or has obligations.

In short, if it doesn’t involve a trustee holding assets on behalf of a beneficiary, under the terms of a trust deed or will, it’s not a trust.

What Are the Main Types of Trusts in Australia?

Understanding the different types of trusts can help you choose the right structure, whether you’re safeguarding family wealth, planning your estate, or investing with others. Here’s a deeper look at the main trust types you’ll come across in Australia.

Discretionary Trust

A discretionary trust is one of the most widely used trust structures in Australia, especially among families and small businesses. In this trust, the trustee has the discretion to decide how income and capital are distributed among beneficiaries, offering flexibility to adapt to changing circumstances.

No one is guaranteed a fixed amount, and distributions can change each year depending on what’s best at the time.

These trusts offer a high level of flexibility, which makes them ideal for managing changing family circumstances, protecting assets and optimising tax outcomes. That’s why they’re often used in family businesses and professional practices.

Unit Trust

A unit trust divides trust property into units, with beneficiaries receiving income and capital based on the number of units they own.

This structure is often used in investment arrangements where multiple unrelated parties come together, such as in property syndicates or joint ventures. It gives each party a clear and fixed entitlement, which can make things easier when everyone wants certainty and transparency.

Hybrid Trust

Combining elements of discretionary and unit trusts, a hybrid trust provides both fixed entitlements for some beneficiaries and discretionary benefits for others, striking a balance between certainty and flexibility.

This setup can be useful when you want the security of fixed interests for some beneficiaries, while also keeping the flexibility to allocate income or capital more freely to others. It’s a more complex structure but offers a tailored balance for more nuanced financial and family goals.

Testamentary Trust

Created through a will and effective after the appointor’s death, a testamentary trust manages assets according to the appointor’s wishes, often used for the benefit of minor children or those with special needs or who need guidance in handling money. They can also provide tax benefits, such as income splitting across family members, and help shield inheritances from creditors or legal disputes.

Bare Trust

A bare trust is the simplest form of trust. In a bare trust, the beneficiary has an immediate and absolute right to both income and capital. The trustee has no real discretion or ongoing management role beyond following instructions.

This type of trust is often used when someone needs to hold property on behalf of another person, such as a parent holding assets for a child until they turn 18. It’s straightforward and efficient, but doesn’t offer the same level of control or protection as other trust types.

Express Trust

An express trust is intentionally created by a settlor, often documented in a trust deed. Most common trust types, such as discretionary, unit, hybrid, and testamentary trusts, fall under this umbrella.

What makes an express trust unique is the clear intention of the settlor to establish the trust, and the terms are set out formally, usually in writing. While it’s not a type you’ll “use” in everyday planning, understanding that it’s the legal category your trust falls into helps clarify your options.

Charitable Trust

Charitable trusts are designed to support public causes rather than individual beneficiaries. They must serve a recognised charitable purpose such as relieving poverty, advancing education, promoting religion, or providing other public benefits.

Unlike private trusts, they don’t need named beneficiaries. Instead, their “beneficiary” is the broader community or a specific cause. These trusts can receive tax concessions, but they’re subject to strict legal requirements and public benefit tests.

Resulting Trust

A resulting trust isn’t planned—it arises automatically in certain situations. For example, if someone contributes funds to purchase an asset but doesn’t receive formal ownership, a resulting trust may be presumed to exist in their favour.

Similarly, if a trust fails or has surplus assets, those may revert to the person who originally contributed them. This type of trust is common in family disputes or property matters where ownership is unclear, but financial contributions were made.

Constructive Trust

Constructive trusts also arise by operation of law, but for different reasons. These trusts are imposed by a court to address situations where it would be unfair for someone to keep property that should belong to someone else.

For instance, if someone gains an asset through fraud, a breach of duty, or under unfair conditions, a constructive trust might be imposed to return that asset to the rightful party. They’re common in family law and estate disputes, especially when formal documentation is lacking but equitable claims exist.

Statutory Trust

Although less common in everyday planning, statutory trusts are created and governed by legislation. These often apply in specific legal contexts, such as intestacy (when someone dies without a will) or under superannuation and property law. They’re not discretionary and usually involve fixed rules around asset handling and distribution.

What are the benefits of each type of trust?

1. Discretionary Trust: Offers flexibility in income and capital distribution, adapting to changing beneficiary needs
2. Unit Trust: Provides a straightforward way to distribute income and capital based on unit ownership
3. Hybrid Trust: Balances fixed entitlements and flexibility to meet diverse beneficiary needs
4. Testamentary Trust: Ensures assets are managed as per the appointor’s wishes, especially for minor children or specific purposes.
5. Bare Trust: Allows immediate beneficiary access to income and capital with minimal trustee intervention.
6. Express Trust: Allows clear intention and structure from the settlor, ensuring the trust operates according to documented terms and offers legal certainty.
7. Charitable Trust: Supports public or community-based causes, offering tax advantages and flexibility in managing assets for approved charitable purposes.
8. Resulting Trust: Arises automatically to return property to the contributor when no clear beneficiary is identified, ensuring fairness in unresolved ownership situations.
9. Constructive Trust: Addresses unfair or improper asset ownership, allowing courts to ensure property is held appropriately even without a formal trust setup.
10. Statutory Trust: Created by law to manage assets in specific legal scenarios such as intestacy or property ownership, ensuring compliance with statutory obligations.

How do I know if I need a trust?

The decision to create a trust depends on the specific business or investment plans you have, as well as your long-term objectives and how you plan to exit your investments. It also depends on factors like the type and value of your assets, your estate planning goals, and any particular worries you might have about protecting your assets or looking after your beneficiaries.   

Who sets it up?

Creating a trust is  complicated and requires expertise and knowledge. A trust is typically set up by the appointor with the assistance of a professional, such as an accountant or a lawyer. The appointor defines the trust’s terms and designates the trustee responsible for managing the assets. If done incorrectly, trust structures can be quite tricky and costly to rectify if a mistake is made. Long story short… come and chat to us!

Anything else I should know about trusts?

Trusts require careful consideration of your goals, ongoing management, and a *trustworthy* trustee. Regular reviews of the trust’s provisions are advisable to ensure they align with your evolving circumstances and objectives.

Frequently Asked Questions About Trusts in Australia

What do trustees have to do?

Trustees are in charge of making sure a trust is run according to the rules set out in the trust deed or will. Their main job is to act in the best interests of the beneficiaries. If the trust is discretionary, the trustee gets to decide what action to take, if any, and when. While the trust deed or will can set some boundaries, trustees generally can’t be forced to act in a specific way.

The core duties of a trustee include:

• Following the trust terms exactly as outlined.
• Regularly considering how to use the trust funds or assets to benefit the beneficiaries.
• Investing the trust assets responsibly, following any specific instructions in the trust.
• Avoiding unnecessary costs or wasting the trust’s property.
• Seeking professional advice, legal, financial, medical, or other, if needed, with the trust covering those costs.
• Keeping accurate records of everything, including income, expenses, assets, and liabilities, and being prepared to explain those details to beneficiaries if requested.
  

What are the rights of the trustees?

Trustees also have rights to support them in carrying out their duties. They can:

• Be reimbursed from the trust for any reasonable expenses they incur while managing it.
• Apply to the Supreme Court for guidance if they’re unsure about what the trust allows or requires, especially when decisions carry legal risk.
• Receive compensation for their time and effort if the trust deed or will allows it. This can be a good idea, as trustees often carry significant responsibility and may need to dedicate a lot of time to making the right decisions.
• Appoint someone else to step in as a new or replacement trustee if the original trustee steps down or can’t continue.
  

What rights does the beneficiary have?

Beneficiaries have the right to see that the trust is being managed according to its terms. They can request assistance or distributions from the trustee, and they can expect their interests to be taken seriously, but they usually can’t force the trustee to act in a particular way unless the trust says so.

Beneficiaries can ask for an accounting of how the trust is being run, though trustees aren’t usually required to explain every decision they make. If a beneficiary believes the trust isn’t being managed properly, they can take the issue to court, but that can be costly and should be a last resort. If the beneficiary has a disability, they may need someone to help them through the process.

While beneficiaries do have rights, trustees often need to think long term. A decision that seems good now, like using a big chunk of trust money, might not be wise if it leaves the trust short on resources later.

How are trusts taxed?

A trust is treated as a separate legal structure for tax purposes, and it has its tax obligations. Trustees must lodge tax returns and pay any tax due. Depending on how the trust is managed, tax might be paid by the trust itself or passed on to the beneficiaries who receive income from it.

Unlike individuals, trusts aren’t entitled to a tax-free threshold. If the trust keeps income rather than distributing it, that retained income could be taxed at the highest personal rate. However, if a trust was created through a will, also known as a testamentary trust, it may be taxed at the normal personal tax rates, which can offer some savings.

These tax rules can be complex, so it’s a good idea to get professional advice before setting up or managing a trust.

Are there other costs of maintaining a trust?

Yes, there are. If a trustee hires an accountant to handle tax returns or financial statements, those services will cost money. If the trustee is a company, there are extra legal and accounting fees to set it up and keep it running.

It’s important to think ahead: Is there enough capital in the trust to generate income to cover these expenses and still provide value to the beneficiaries? That’s something to discuss with your accountant or adviser before deciding when and how to set up a trust.

What is a testamentary trust?

A testamentary trust is set up in a person’s will and only comes into effect after that person passes away. It’s a way to manage the distribution of your estate and can provide tax advantages and asset protection for your beneficiaries.

Is a testamentary trust different from a family trust?

Yes, they’re different in both timing and tax treatment. A family trust is usually created during your lifetime, while a testamentary trust only begins after your death.

One key difference is the tax benefit for younger beneficiaries. In a family trust, children under 18 are taxed heavily on the income they receive above a small limit. But in a testamentary trust, those same young beneficiaries can access the full tax-free threshold, meaning they pay less tax on income from the trust.

Because tax laws can change, it’s smart to include a testamentary trust in your will as an option, even if you’re unsure whether it will be needed right now.

Who can be the trustee of a testamentary trust?

You can name almost anyone you like as a trustee: your partner, children, executors of your will, or even a professional adviser. Since the trustee will manage your estate on behalf of others, it’s important to choose someone you trust to act responsibly and in the best interests of your beneficiaries.

You can also set up multiple testamentary trusts under the same will and appoint different trustees for each one.

What’s the difference between a settlor and an appointor?

The settlor is the person who sets up the trust by signing the trust deed and putting in an initial amount of money (usually a nominal amount like $10). This gets the trust up and running. However, the settlor must not be a family member or beneficiary, as they can’t benefit from the trust.

The appointor is the person who has the power to hire or remove trustees. In many ways, the appointor is the one who ultimately controls the trust. You can appoint yourself, or yourself and your spouse, as the appointor to maintain control.

If I leave my estate to a testamentary trust, can my spouse access the money?

Yes, as long as your spouse is listed as a beneficiary of the trust. The trustee would then be able to pay income or capital to them, depending on the terms you’ve included in the trust.

Are there other advantages to a testamentary trust besides tax benefits?

Definitely. A testamentary trust can also protect assets from creditors or legal claims, and it can help safeguard assets for beneficiaries who are vulnerable, like those with intellectual impairments or spending issues.

What should I consider before including a testamentary trust in my will?

There are a few important things to weigh up. One is whether your estate will have enough income to make maintaining the trust worthwhile, especially given the ongoing costs like accountant fees. You should also think about whether you have any beneficiaries who might need extra protection, such as someone with a disability.

If your assets are mostly held jointly or through an existing family trust, your estate might not be large enough for a testamentary trust to make sense. If you’re unsure, it’s a good idea to include it in your will as an option, this way, the trustee can decide at the right time whether or not to activate it.

What if I already have a family trust?

Assets owned by your family trust aren’t part of your estate, so they won’t be affected by a testamentary trust. If all your wealth is tied up in a family trust, a testamentary trust might not add much value unless you plan to transfer those assets out of the family trust before you pass away.

Can I set up a similar trust after I die if I don’t change my will now?

It’s possible to establish a trust after death, but there are restrictions. Only the people who would have inherited under intestacy laws (the default rules if you don’t have a will) can benefit, and they’ll have to receive the assets in fixed shares. In contrast, a testamentary trust gives the trustee flexibility to distribute assets as they see fit among the named beneficiaries.

What advice should I get before setting up a testamentary trust?

Speak with your accountant, solicitor, or financial adviser. They’ll help you weigh up the pros and cons, especially as they relate to your personal and financial situation. It’s also worth including a testamentary trust in your will as a backup plan, just in case your circumstances or your beneficiaries’ needs change down the track.