Five ways to avoid a family wealth battle

The Rinehart family feud has quickly become Australia’s finest soap opera. But there’s also a lesson to be learned from this tumultuous drama: how not to go about wealth succession and estate planning.

If anything, the sight of Australia’s richest woman and one of her daughters in open conflict with the rest of her family over the family fortune tells us that money alone is no solution … you need a robust strategy.

But first, what is a family trust and how does it work? Family trusts had their heyday in the 1960s and 1970s, when there were a greater number of tax benefits, says Phillip McGowan, director of de Groots wills and estate lawyers. Once these benefits were taken away, there was a bit of a slowdown in the 1980s, but over the past 15 years family trusts have again become more popular, in part because they provide a great deal of protection for the family’s assets.

“Once a person transfers assets from their own name into a trust the person ceases to be the owner of the assets. This means if the person is subsequently sued the assets should be protected.  So people at risk of being sued, such as business owners, company directors and professionals such as doctors and lawyers generally prefer their wealth to be held in a family trust and not their own personal name,” says Bernie O’Sullivan, principal of independent law firm Bernie O’Sullivan Lawyers.

The protection of assets also applies in cases of bankruptcy.

“The assets that are in the family trust generally are immune from attack by creditors. So mum and dad have put assets in the family trust, one of them goes bankrupt, and provided they haven’t transferred assets in there with the intention of defeating those creditors or gifted them to the trust in the four years before they went bankrupt, those assets aren’t their own personal assets, they’re owned by the trustees of the trust. The creditors can’t get their hands on them,” McGowan says.

There are also still some tax advantages to establishing a family trust. If the assets in the trust generate income, then the trust allows for that income to be distributed to beneficiaries in such a way as to minimise the tax payable. For example, the trustee can choose to allocate the distributions to family members earning the lowest income in order to take advantage of the tax-free threshold of $18,200. Keep in mind though that for children under the age of 18, the tax-free threshold is much lower, at just $416 per year.

Family trusts have their pitfalls too. Always established with the best of intentions, the discretionary aspect means disputes are not solely reserved for the Rineharts of the world. The problem is all the wealth is tied up together. Moving from the first generation to the next, that wealth then needs to be controlled by and distributed amongst a greater number of people, which inevitably leads to a greater number of disputes. (For more on inter-generational planning, see our Barron’s story today – Estate planning for modern families).

“Disputes are increasing at a dramatic rate. This is especially the case in circumstances where the parents, who have controlled the trust for years, die or become incapacitated and a new controller takes over and realises – to their delight – that the trust is discretionary and they can benefit themselves to the exclusion of others,” O’Sullivan says.

In cases where there is a lot of wealth tied up in the family trust, sometimes the only solution is for one family to ‘break away’ and start another business, McGowan says.

“We’ve probably seen it with some of the wine growing families. They would’ve had their vineyard and the winery through a discretionary family trust when it was first created and then the two brothers are running the business after mum and dad die. They have a dispute about how it should be managed and how it should be distributed, one has two kids, the other has six kids. How do you get equality in those circumstances? So one of them will perhaps get a payout and they’ll go and start their own competitor winery,” he says.

Money and greed are often blamed for ripping families apart, but in the case of family trusts, there are ways to minimise and prepare for potential problems. Here are the five most important issues to consider when establishing a family trust:

1. Do your research

Find out if it’s even worth establishing a family trust in the first place. It’s important to see how the control of the trust should be structured, to look at the complexities it brings to the management of someone’s affairs, and whether the protection that it gives and the income tax benefits that it gives make it worth establishing a family trust in the long run rather than owning assets in your own name.

2. Plan the finish before you begin

If you decide to go ahead with a family trust, remember that they have a life span. In all Australian states except South Australia, a family trust can exist for a maximum of 80 years. There’s a lot to think about and a lot of questions that need to be answered well ahead of time.

“Right from the very outset, look to the end point about what needs to happen when you pass away. If the trust is going to have significant assets in it, make sure that the governance by way of family agreements, shareholder agreements, family constitutions et cetera is properly structured and contains all the rules that they need to,” McGowan says.

It’s critical to establish a succession plan, not only for the role of trustee but also the role of ‘appointor’ of the family trust, O’Sullivan says. The appointer, or principal, has the power to appoint or remove the trustee, so is arguably even more powerful than the trustee.

3. Consider a guardian

Family dynamics play an important part in any succession plan for a family trust. Remember, these are discretionary trusts, meaning the trustee has an awful lot of power. Just look at Gina Rinehart’s decision as trustee to extend the vesting date of the Hope Margaret Hancock Trust to 2068.

Where there is potential for conflict within the family, appointing a guardian to the trust can be beneficial. A guardian is someone who can control whether or not the terms of the trust deed can be changed. Essentially, the role of the guardian is to provide an extra check on the extensive powers of the trustee.

4. Have a strategy for dispute resolution

It’s not always possible to play happy families, especially where money is concerned. In the case of the Rineharts, Gina has steadfastly endeavoured to have the feud resolved behind closed doors, through mediation and arbitration. Her latest bid for arbitration was rejected in favour of mediation between the parties, but to no avail. The battle still went to the NSW Supreme Court earlier this month, and the Rineharts are currently awaiting a decision on who will be the new trustee following Gina’s decision to step down.

It’s not very common to see arbitration as part of the resolution process in a family trust, McGowan says, with it typically being reserved for commercial parties rather than families. Mediation is a more common approach.

“Generally in most family groups there would be a mediation-type process, where you get an independent mediator getting all the disgruntled parties together and trying to get them to come to some kind of solution. In a family trust, simply because of the nature of family groups, you usually don’t see an arbitration provision, but I think mediation is certainly an option,” he says.

5. Abide by the trust deed

It’s critical to abide by the trust deed, as well as keeping proper records and making annual income resolutions by the required date, O’Sullivan says. In August of this year, the Australian Taxation Office (ATO) announced that family trusts would be targeted by its ‘Trusts Taskforce’ as part of its compliance program. For more information on this, go to the ATO website here.

O’Sullivan also recommends having a careful read of the trust deed or having an adviser summarise its provisions.

“Many clients assume all deeds are the same, which they are not  – we recently had a case where a second spouse received sizable distributions for years until other (disgruntled) beneficiaries discovered that she was not a beneficiary and tried to force her to repay the lot,” he says.