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It is a situation that no family wants to imagine, let alone plan for. However, in the event of a family breakdown, establishing a child maintenance trust can save you thousands.
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How a child maintenance trust can save divorcees thousands
20 December 2019
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9 minute read
While many parents already organise their personal affairs into a cost-effective family tax structure, they often aren’t using the same tools to prepare for their children’s future.
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There is no doubt that the breakdown of a marriage or family relationship is a stressful and expensive process. After legal fees and court dates, a parent saddled with paying child support will often pay these funds out of their after-tax earnings, and those payments will be taxed heavily.
But with the help of a financial adviser, parents can take advantage of a loophole which allows them to provide income for their children in a more cost-effective way.
How? It comes down to having a comprehensive knowledge of Australian tax law.
Generally, income earned by a minor is taxed at the highest marginal rate once it exceeds $416 a year. But in transferring assets to the child or children via a trust, the first $18,000 of this money can be free of income tax.
Of course, this loophole has certain terms and conditions attached. The trustee should be a parent of the child or children who benefit, and no longer be married to their spouse. There must also be a court order, child support assessment or agreement in place that requires the parent to pay the support.
When the trust is structured well, the “property” within the trust — a term which includes money, securities, real estate or life insurance policies under the law — can earn an additional income over time.
The savings can be significant.
For example, if a paying parent had three children and the assets in a trust generated $90,000 in income, the total tax payable would be just $7,191. In the same situation, if the parent was paying child support after tax, they would be taxed up to $42,300 at the top marginal rate.
That means that those trust payments could generate a saving of over $35,000 a year, or $350,000 over 10 years.
Of course, as with most trusts, the property in the trust must ultimately be transferred to the children. Sometimes, parents don’t want to give certain valuable capital assets away.
The role of a tax adviser is to help parents to identify property that they are ultimately happy for their children to keep. These assets also need to generate sufficient income to make the establishment of a trust worthwhile.
Albeit a difficult time for the family relationship, consulting with a family office or tax adviser at the time of your divorce can ensure you avoid unnecessary out-of-pocket costs.
With lower tax rates and higher returns, it’s an investment in your family that will pay dividends for years to come.
By Geoff Thompson, tax partner, Pitcher Partners Newcastle
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