RP Data’s Chris Spanos offers a primer on the ins and outs of trusts
By now almost everybody who works in property has heard of an SMSF, but many still don’t know that SMSFs are a type of legal entity known as a trust.
So, what is a trust, what are its elements and why are SMSFs structured as trusts?
What is a trust?
Under the British common law system we inherited, the law only recognised one type of property owner – the strict legal owner.
This had all sorts of unintended consequences and left no room for structures or bequests like “I want to leave this house for the benefit of my child that is aged five, but would like my brother to control the asset until my child is of age”. If your brother ran off with the proceeds of an asset sale in his own name, there was little anyone could do to enforce your original intent.
To solve this dilemma, the law of equity evolved, allowing for a legal owner and a simultaneous beneficial owner. Additionally, the legal owner of property would have a fiduciary obligation to act in the best interests of the beneficial owner. The easiest way to understand a fiduciary duty is to think of the relationship between a parent and child, or in abusiveness context the duty of directors to act in the best interests of the company. A trust is a structure whereby trustees are the legal owners of the assets held within the trust, and are required to deal with these in the best interests of the beneficiaries.
What are the essential elements of a trust?
Just as a company has a constitution, shareholders and a board, what are the elements that make up a trust and how do they work together? The settlor places assets into the trust, the trustee is given legal ownership of those assets, and the beneficiary is the ultimate equitable owner of the assets. When establishing a trust, the settlor must demonstrate a clear intent to transfer assets into the legal ownership of a trustee for the benefit of a beneficiary– this intent is generally declared in a trust deed.
The settlor can also decide on whether a trust will be fixed or discretionary, which limits or empowers trustees to decide how and when assets are distributed to beneficiaries. An SMSF is a unique type of trust that is heavily regulated by statute. One of the key differences between an SMSF and a regular trust is that distributions to beneficiaries cannot be made until certain prescribed events occur, such as reaching retirement age or being permanently incapacitated.
So why are SMSFs structured as trusts?
Given the above, it should be relatively apparent why trusts became the preferred SMSF legal structure. The standard elements of a trust help to achieve the stated goals of an SMSF – that is, assets can be pooled and managed by a legal owner (the owner may be a corporation) for the benefit of all nominated SMSF beneficiaries. The beneficiaries can include a spouse and children, allowing families to create a retirement nest egg while setting aside funds for their children’s future.
Rather than create a completely new legal structure to help administer retirement assets, Australian legislators smartly leveraged a pre-existing structure. Attempting to read an SMSF trust deed with no context can be confusing, to say the least. Hopefully the discussion above will help you better understand the meaning of your SMSF trust deed when you next embark on some bedtime reading!
This article originally appeared in Australian Broker 11.24.
So, what is a trust, what are its elements and why are SMSFs structured as trusts?
What is a trust?
Under the British common law system we inherited, the law only recognised one type of property owner – the strict legal owner.
This had all sorts of unintended consequences and left no room for structures or bequests like “I want to leave this house for the benefit of my child that is aged five, but would like my brother to control the asset until my child is of age”. If your brother ran off with the proceeds of an asset sale in his own name, there was little anyone could do to enforce your original intent.
To solve this dilemma, the law of equity evolved, allowing for a legal owner and a simultaneous beneficial owner. Additionally, the legal owner of property would have a fiduciary obligation to act in the best interests of the beneficial owner. The easiest way to understand a fiduciary duty is to think of the relationship between a parent and child, or in abusiveness context the duty of directors to act in the best interests of the company. A trust is a structure whereby trustees are the legal owners of the assets held within the trust, and are required to deal with these in the best interests of the beneficiaries.
What are the essential elements of a trust?
Just as a company has a constitution, shareholders and a board, what are the elements that make up a trust and how do they work together? The settlor places assets into the trust, the trustee is given legal ownership of those assets, and the beneficiary is the ultimate equitable owner of the assets. When establishing a trust, the settlor must demonstrate a clear intent to transfer assets into the legal ownership of a trustee for the benefit of a beneficiary– this intent is generally declared in a trust deed.
The settlor can also decide on whether a trust will be fixed or discretionary, which limits or empowers trustees to decide how and when assets are distributed to beneficiaries. An SMSF is a unique type of trust that is heavily regulated by statute. One of the key differences between an SMSF and a regular trust is that distributions to beneficiaries cannot be made until certain prescribed events occur, such as reaching retirement age or being permanently incapacitated.
So why are SMSFs structured as trusts?
Given the above, it should be relatively apparent why trusts became the preferred SMSF legal structure. The standard elements of a trust help to achieve the stated goals of an SMSF – that is, assets can be pooled and managed by a legal owner (the owner may be a corporation) for the benefit of all nominated SMSF beneficiaries. The beneficiaries can include a spouse and children, allowing families to create a retirement nest egg while setting aside funds for their children’s future.
Rather than create a completely new legal structure to help administer retirement assets, Australian legislators smartly leveraged a pre-existing structure. Attempting to read an SMSF trust deed with no context can be confusing, to say the least. Hopefully the discussion above will help you better understand the meaning of your SMSF trust deed when you next embark on some bedtime reading!
This article originally appeared in Australian Broker 11.24.
