Understanding special disability trusts
By Janet Manzanero-Caruana, Senior Technical Services Manager
The benefits of a special disability trust (SDT), a trust established to provide for the care and accommodation needs of a person with a severe disability or medical condition, for its donors (usually parents or immediate family members) and the principal beneficiary (PB) are substantial.
Not only is an SDT a means to provide for the future care of the PB, it provides significant social security and tax concessions for both donors and the principal beneficiary.
However, prior to setting up an SDT, trust restrictions, trustee responsibilities and the cost effectiveness of an SDT should be carefully considered by all stakeholders.
Special disability trusts
An SDT is usually set up by the parents or immediate relatives (or through a Will) primarily to privately fund the future care and accommodation needs of a severely disabled loved one.
An SDT must satisfy the following requirements:
- It must have a sole beneficiary - a principal beneficiary who must meet the definition of having a severe disability. Only one SDT can be set up for the PB. Provisions may be made for residual beneficiaries (such as when the SDT is wound up after the PB’s death).
- It must be established primarily to provide for the accommodation and care needs of the PB.
- Its trust deed has all the required clauses contained in the model trust deed, which may be found on the Department of Social Services website. The deed can have other provisions, but these must be consistent with the required clauses.
- It must have at least two individual trustees (either friends or family), or a professional trustee (such as a trustee corporation or an Australian legal practitioner).
- The trustees of the SDT must have an investment strategy and comply with investment rules
- Other than paying for the PB’s care and accommodation costs, limited discretionary spending must relate to the promotion of the PB’s health and wellbeing, recreation, self-sufficiency and/or social inclusion.
- The PB’s parent, stepparent, legal guardian, grandparent or sibling (immediate family members) cannot be paid or benefit from the SDT’s assets.
- The trustee of the SDT provide Centrelink/the Department of Veteran’s Affairs (DVA) annual financial statements, any trust tax returns and a statutory declaration. Financial statements are prepared by the professional trustee who cannot be an immediate family member.
- Independent audits must be conducted when required.
The above requirements must be met otherwise the SDT can lose its SDT status and related concessions. Trustees may apply to the Department of Human Services/Department of Veterans’ Affairs for consideration in limited instances.
Social security and tax concessions
While SDTs are set up to provide financial assurance that the PB’s care and accommodation needs are met, SDTs also come with significant social security and tax concessions.
Exempt SDT assets and income
SDT assets are assessed to the PB, however, the value of its assets up to $694,000 (as at 1 July 2020) are disregarded for the assets means test. In addition, a PB’s principal home held by the SDT trustee is an exempt asset.
All SDT income is classified as exempt income for social security purposes. These additional exemptions are in addition to the usual income and asset free thresholds or limits. Together these exemptions may potentially allow for increased disability support pensions.
Anyone can contribute to an SDT except for the settlor (this is the entity that created the SDT). The PB and their spouse can only contribute proceeds from a bequest or superannuation death benefit which they received within the last three years before the transfer to the SDT. Compensation received for, or on behalf of, the PB cannot be donated to the SDT.
|Example: Social security means test exemptions|
Carlo and Maxine are a couple with minimal assets apart from the refundable accommodation deposits (RAD) they paid when they entered an aged care home. They receive the full age pension ($24,551.80 pa each as at 1 July 2020).
Carlo passes away and his RAD (total value of $600,000) is refunded to his estate. Maxine is the sole beneficiary of Carlo’s estate and as a result she will lose her age pension after the deceased estate is fully administered. This is because her assessable assets will exceed the asset cut-off threshold (currently $583,000).
An SDT is set up for Maxine. Maxine is an eligible PB of an SDT as she resides in an aged care facility due to her severe disability. She transfers the $500,000 to the SDT.
Maxine personally holds $250,000 worth of financial assets and $5,000 in personal assets. SDT assets (which fall within the exempt asset limit) and income are disregarded.
Her assessable assets total $255,000 which means she qualifies for the full pension under the pension income and assets tests. As a result, she retains the full age pension.
Immediate family members who are at least age pension age and receive social security income support can donate combined assets of up to $500,000 to a SDT without social security gifting rules applying.
This allows family to set aside funds for a severely disabled loved one and retain, increase or reduce the impact on their own social security benefits.
Donors must be paid back their proportionate share of residual SDT assets if the trust is wound up within five years of donating, otherwise deprivation rules will apply for the remainder of the five-year period.
Donors must consider their own financial circumstances and security because donations are unconditional and they cannot be paid or benefit from the SDT in return.
Disregarded capital gains and losses
Any capital gain or loss realised when an asset is donated to an SDT is disregarded. The advantage is that donations made in-specie will not incur any capital gains tax (CGT). The cost base (reduced cost base) of the asset for the SDT trustee is the market value at the time it is acquired by the SDT. A bequest from a deceased estate will have the market value of the asset as at the date of death of the testator recorded as the cost base.
|Example: Concessions for donations to SDTs|
Mary is a widower and homeowner with assessable assets valued at $350,000 (made up of $340,000 in financial investments and $10,000 in other assets). She currently receives $698.30 per fortnight (or $18,155.80 per annum) as an age pension. She expects an inheritance worth $600,000 in shares. Her assessable assets combined with the inheritance will increase to $950,000, which is greater than the $583,000 asset cut off threshold for single homeowners.
Mary wishes to give her inheritance to her severely disabled daughter, Jodie, to help with Jodie’s future care expenses. If she gives the shares to Jodie, the amount exceeding $10,000 will be assessed under the pension means tests for five years - and Mary will still lose her age pension. She may also be taxed on any net capital gains from the disposal of her shares.
Jodie is eligible to be a PB of an SDT. If Mary transfers her inheritance to an SDT set up for Jodie, Mary can retain part of her age pension. Deprivation rules do not apply to donations within the $500,000 gifting exemption. Any capital gain/loss is disregarded so there are no tax implications for Mary. The SDT trustee’s cost bases for the shares will be the market value at the time of these are acquired from Mary.
CGT main residence and principal home exemptions
A full or partial CGT main residence exemption is available to the SDT trustee (ultimately to the PB) if the PB is not an excluded non-resident. The exemption also extends to the trustee or beneficiary of the resulting trust generally within two years of the PB’s death.
Some States and Territories allow stamp duty concessions on transfers of property to special disability trusts.
However, consideration should be given as to whether the PB’s home should be held in the SDT rather than by the PB personally. What happens if the PB vacates the home and it is rented for a long time?
Tax rules allow the PB’s home to be rented for up to six years and still be elected as the person’s main residence. However, for social security purposes the home can only be exempt for up to two years where the PB enters a care situation (for example an aged care home or moving to someone’s home to receive care for more than two weeks). The home then becomes an assessable social security asset after the two-year exemption period (unless grandfathered rules apply, which require the home to be rented and the person pays ongoing accommodation payments). Social security assessment of the home may cause the reduction if not loss of the PB’s pension.
While the tax and social security treatment of the home is similar if it is held by the PB personally or by the SDT trustee, immediate family cannot live in the home if it is held by the SDT trustee. If the home is owned by the PB, there are no restrictions to the use of the home. Family members can live in it rent free or may rent at non-arms’ length rates.
SDTs can accumulate income to ensure its payments relate only to allowed expenses. SDT income is taxed at the PB adult tax rates even where the PB is a minor (excepted person for the purposes of s102AC of ITAA 1936). Adult tax rates (rather than the 47% penalty tax rate) also apply where income is not distributed by the trustee.
SDTs may allow income-splitting benefits for family who fund the care and accommodation of a child.
|Example: Income splitting|
Luis and Gemma have a severely disabled son, Paulo, aged 10. They both earn over $300,000 pa each and have a jointly owned share portfolio worth $1.5 million with an income return of $60,000 pa.
The couple have set aside the share portfolio primarily for Paulo’s care costs. The effective tax paid on the $60,000 pa is approximately $28,200 pa (equal to 47% with Medicare levy) - a net income is $31,800 pa.
They set up an SDT for Paulo and donate their share portfolio. Gemma and Luis are SDT trustees. SDT income is taxed at adult rates to Paulo, who is classified as an excepted person for tax purposes. The effective tax paid is $11,067 pa (rates as at July 2020) and the net income is $48,933 pa.
The tax saving is about $17,133 pa (equal to $28,200 less $11,067). However, Luis and Gemma must consider the SDT’s running costs, their trustee obligations, and that they are restricted from using or being paid from SDT assets.
There are strict rules about dealings with related parties.
Related parties include:
- the settlor of the trust, unless the trust was created by a Will
- the trustee other than a professional trustee
- the donor to the trust
- the PB
- the appointor of the trust
- immediate family members of the PB
- a parent, sibling, partner, or descendant of an immediate family member
- any entity which any of the people listed above is a director, shareholder, trustee, or can appoint a director or trustee, except publicly listed company.
SDT trustees cannot do the following:
- Lend or provide financial assistance to a related party. For example, a company owned by the PB’s parents borrow from the SDT even if the borrowing complies with investment strategy provisions.
- Purchase assets from a related party except for listed securities at market value. However, assets can be received from a related party provided these are unconditional donations to the SDT.
- Hold shares in company that is a related party, even if these are gifted, unless these are listed company shares.
- Lease property from an immediate family member or a PB’s child even if the PB will live in the property. They cannot enter into non-arms’ length transactions with related parties such as leasing or selling property for less than market value.
- Pay related parties for any services provided to the trust or the PB. For example, a son cannot be paid by the SDT trustee to drive the PB (his father) to regular specialist appointments.
Breaching SDT restrictions may result in the loss or reduced social security pensions for the PB and certain donors as SDT assets become fully assessable to the PB and gifting concessions for donors will not apply. In some instances where gifting rules will not apply, some or all SDT assets may be attributed to a donor.
Any unexpended SDT income in a financial year can be taxed to the trustee at 47%.
Weighing up the pros and cons of an SDT
If a family has a person with a severe disability, an SDT may improve the social security position of the disabled individual and/or immediate family member that contributes to the SDT.
Importantly, any potential benefits should be balanced against the costs of establishing and maintaining the SDT. Where possible the PB’s disability, long-term care needs and expected life expectancy should be considered.
An SDT must have two individual trustees unless a professional trustee is appointed. This poses questions, for example, who can be trustees, alternative trustees? Who should be the appointor and alternative appointor? Are there willing family or friends who understand how an SDT must be managed and are willing to take on the long-term roles for which they cannot be remunerated?
Some parents of a disabled child may not wish to leave complex arrangements for others to administer when they are no longer around so may look to appointing a professional trustee such as a state trustee, trustee corporation or a solicitor. However, there are additional costs for professional trustee services. Upfront and ongoing fees usually vary depending on the trustee and the value of SDT assets – but these can be substantial.
The running costs may also impact the viability of setting up and managing an SDT, especially where the value of SDT assets have diminished or investment returns are low.
Estate planning, tax and social security advantages must be weighed against the SDT’s running costs, trustee responsibilities and restrictive rules. Alternative options such as family trusts, which may have less restrictive terms, could be considered. Government subsidies (such as the National Disability Insurance Scheme (NDIS)) and other programs may also supplement the PB’s needs and are worth exploring.
If you have any questions, or would like more information, please contact the IOOF TechConnect team on 1300 650 414.
The information in this section of the website is intended for financial advisers only and is not to be distributed to clients. It has been prepared on behalf of Australian Executor Trustees Limited ABN 84 007 869 794 AFSL 240023, IOOF Investment Management Limited ABN 53 006 695 021 AFSL 230524, IOOF Investment Services Ltd ABN 80 007 350 405, AFSL 230703 and IOOF Ltd ABN 21 087 649 625 AFSL 230522 based on information that is believed to be accurate and reliable at the time of publication.