To trust or not to trust – the benefits of a discretionary (family) trust – final comparison

I have discussed the benefits of a discretionary trust aka family trust for minimising capital gains tax (CGT). I have also discussed the benefits of a discretionary trust from minimising taxable income. For this last part I am going to compare a discretionary trust against a direct 50-50 split over an average person’s lifespan.

Again similar to the previous examples a 50-50 split is exactly that, two persons owning half a property each, any income is split equally. Also as per previous examples, one person will be earning a secondary external income of $100,000. As before, I have assumed a $1,000 annual fee for trust management.

The following examples try to emulate a real world situation, the purchase of a property, initially purchased under a mortgage with some rent, initially the property will be negative geared. I have assumed all income after tax goes into paying the mortgage, this would never be the case in the real world, so the examples below show the property being paid off much quicker than normal. Finally, once the properties has been paid off savings are accumulated which includes interest. This interest in the same as the mortgage interest, which wouldn’t be the case as it would always be slightly lower.

As previously discussed a 50-50 split is always more beneficial compared to a discretionary trust when the properties are negatively geared, so to make things interesting I have added cases were they begin with a 50-50 split, then once the property is positively geared it changes to a discretionary trust.

The following scenarios are used for the situations;

  • 50-50 – a split of the property when each person owns an even 50%
  • Trust 2pers – a discretionary trust with 2 beneficiaries
  • Combo – starting with a 50-50 split and then moving to a trust with 2 beneficiaries once the property is positively geared
  • Trust 3pers – a discretionary trust with 3 beneficiaries
  • Combo2 – starting with a 50-50 split and then moving to a trust with 3 beneficiaries once the property is positively geared

Example 1 – mortgage $500,000, rental yield 2.5% and interest 7%

First a 30 year chart of the yearly income after tax

$500000, 30 year chart of the yearly income after tax

The first abnormality that can be observed on the combo situations is a bump in income at around the 5 year mark, this is the point where the property goes from negatively geared to positively geared, and as I stated above, this is when the combo situations move from a 50-50 split to a trust. But why the bump/ well, because you have changed the title from two persons to a trust, stamp duty is payable, for a $500,000 property roughly $18,000 is payable. Stamp duty is what makes it unappealing to move to and from a trust situation, it is the believed reason key decisions about the trusts need to be made early on, as it is expensive to change your decision later on.

Looking at the cumulative wealth over 30 years, this provides a clearer picture

$500000, cumulative wealth over 30 years

Straight away, at 30 years the order of scenarios providing the best return in descending order are the second combo, the three person trust, the 50-50 split, the first combo and lastly the two person trust. The difference between the best and worst results is $280,000 which is very significant for a 30 year projection. The difference at around 10 years is only $20,000, since the trusts are playing catch-up from the period of negatively gearing. If you look closely it can be observed the two combo scenarios have a very slight dip around that fifth year corresponding to the stamp duty.

Example 2 – mortgage $1,000,000, rental yield 2.5% and interest 7%

Again, a 30 year chart of the yearly income after tax

$1000000, 30 year chart of the yearly income after tax

A couple of things to notice, first the bump at the 13 year mark signals where the property moved from negative geared to positive geared, a larger mortgage means longer time to pay off. A higher valued property also means more stamp duty for $1,000,000 the stamp duty is around $43,000.

Looking at the cumulative wealth over 30 years

$1000000, cumulative wealth over 30 years

Firstly, the order of scenarios after a 30 year projection has changed, the 50-50 split and combos are in the lead, whilst the two trust scenarios are trailing.  The difference between the best and worst results is $250,000 which is very significant for a 30 year projection.  We can see the affects of the stamp duty a lot more clearly on the light blue and green lines and the trusts only scenarios never recover from the start.

But what if the cumulative wealth is projected over 50 years

$1000000, cumulative wealth over 50 years

The trust scenarios are back in the lead. Because of the larger time negatively geared and larger stamp duty, the trust scenarios needed more time to ‘catch up’.

Example 3 – mortgage $250,000, rental yield 2.5% and interest 7%

As above, a 30 year chart of the yearly income after tax

$250000, 30 year chart of the yearly income after tax

As expected, there is a very short period of negative gearing, roughly 3 years. Due to the relatively low value property, the stamp duty is also minor at $7,000.

Looking at the cumulative wealth over 30 years

$250000, cumulative wealth over 30 years

As expected, due to the short negatively geared period, the trusts are beneficial for the majority of the projection period.

Conclusion

So what does this all mean?

Making the correct decision about trusts can save you hundreds of thousands of dollars in the long run. In general if a property is positively geared it would benefit if it is in a trust and if a property is negatively geared it would benefit if owned individually.

The good news is, if planning to hold for the long term it, it can be decided to move to a discretionary trust scenario, as the benefits will eventually out way the costs. When the property is positively geared move it to a trusts, but be prepared to hold it to offset the stamp duty.