Your money: How family trusts work in the real world

Theory is fine, but to see how a family trust can work in practice, take the example of a couple we'll call Jim and Rosemary Brown.

Jim and Rosemary had been successful in business and had also inherited funds from their parents. Both in their mid 40s, they had three children: Bruce, Peter and Mary, aged 17,15 and 13 respectively.

They decided to set up a family trust with an external professional trustee for the benefit of the family. The trust deed also allowed the trustee some discretion to make payments to the spouses of the children and grandchildren and to provide for Jim's mother.

They transferred assets into the trust, selecting growth assets including shares and other investments which they expected to grow.

While the children were still at secondary school there were few drawings on the trust and Jim and Rosemary allowed the income to be re-invested so the trust's capital would build up faster. They also continued making regular gifts to the trust.

After their secondary education, two of the children decided to go to university and it was possible to assist with their fees and other expenses from the trust. Income was applied to them and - as the children had little other income - that part of the income was taxed at the children's tax rate.

If Jim and Rosemary had paid the costs out of their own pockets, the income to meet these costs would have been taxed at their higher personal tax rate.

The other son, Peter, decided to become a computer technician and the trust provided some funds for the purchase of equipment.

Unfortunately for Jim and Rosemary, their business suffered financial difficulties when they were in their 50s. While they managed to sell the remaining assets, they received far less than they had hoped.

Most importantly, though, the assets of the trust were not affected. Even if they had gone bankrupt, the trust would have continued on completely separate as a family nest egg.

Although the trust was reasonably large, Jim decided that as he was no longer going to be able to contribute surplus funds to continue building it up, he would take up a life insurance policy, with the provision that if he died the payout would go to the trust.

Through the years, the trust was able to provide some assistance to Jim's mother, who became hospitalised and needed specialist care. These payments were entirely at the choice and discretion of Jim and Rosemary and the trustee.

With Jim and Rosemary now in their mid 60s, they consider whether the trust should be wound up. Their children are now all well established. They have five grandchildren and have no direct financial need for the capital themselves. Jim and Rosemary decide to allow the trust to continue, and it now concentrates primarily on the educational and other needs of the grandchildren.

Their son, Bruce, falls ill and Jim and Rosemary have the two children live with them for six months, during which Jim and Rosemary draw funds from the trust to help pay for clothing, food and other essentials. As with the other payments made to the children and grandchildren, there is a tax benefit in doing this, because the money is provided for the grandchildren who are on the lowest tax rates.

Well into the future, the trust continues to operate. Jim and Rosemary have died and the trustees now consider the trust's future.

In time the trustees decide to wind it up, distributing the capital one third to each of Jim and Rosemary's children. Two of the families use the capital to establish new family trusts and the process starts again.

* Article provided by Tower Trust.