Following the breakdown of a relationship, parents discussing child support can consider an arrangement to make child support money go further by establishing a Child Maintenance Trust.
In most family trusts, minor children who are beneficiaries are taxed at 47% for every dollar over $416 per annum. This does not apply in the case of a Child Maintenance Trust. In a Child Maintenance Trust, minor children are taxed the same way as adults and have the same marginal rates and tax free thresholds.
An example is where a parent wanted to pay $20,000 per annum to cover child support and school fees for each of three children. If that income was coming out of the parent’s salary, the parent would pay $11,507 income tax, leaving a net amount of $48,493. The same payment for the three children from a Child Maintenance Trust with income of $60,000 would attract tax of $1,134, leaving a net amount of $58,866. The money available for child support would be $10,373 more than if the parent paid it directly from income.
To establish the Child Maintenance Trust, there would need to be enough assets or cash available to settle into the trust to ensure there was enough income and capital to earn an income of $60,000 per annum. Use of a Child Maintenance Trust allows parents to access the lower marginal tax rates of their children.
As the asset from which the payments are made is in a trust, there will be no changes to the amount paid as income fluctuates or if the payer becomes unemployed. The payee for child support has the assurance that child support will continue regularly. A Child Maintenance Trust is also useful where the payer lives overseas or has the bulk of their assets held overseas. For the payer, the use of the Trust ensures the funds settled for the children are being spent for their benefit.
There are complex rules about how Child Maintenance Trusts are able to take advantage of the generous tax treatment so professional advice is necessary.
To establish a Child Maintenance Trust and vest income producing property in the Trust which would satisfy child support obligations:
(a) There must be a court order, an assessment or agreement under the child support laws which requires a parent or both parents to pay child support.
(b) A parent or the parents would transfer property to the Child Maintenance Trust to comply with that legal obligation.
(c) The Trust Deed must provide that:
- the property transferred to the trust must ultimately vest in the child when the Trust ends
- if the child dies before the trust ends, the property must pass to the child’s estate
- the trust must contribute to the maintenance of the child beneficiary;
- the Trustee has a discretion to apply the capital of the trust for the child’s benefit during the term of the trust; and
- the child is to receive income from the investment of the trust property at an arm’s length rate of return, but the child does not have to receive all of the income of the trust.
The effect of setting up a Child Maintenance Trust and transferring incoming producing assets into that trust is that the parent’s income tax is reduced. The tax paid by the trust is less than the tax paid by the payer on the income earned to pay the child support. The savings can be substantial, but the negative aspect is that the payer loses ownership of the income producing asset.