Family Trust Election (FTE) and retirement: the family group, franking credits, and the 47% distribution tax

For Australian retirees who hold a family discretionary trust — set up years or decades ago for asset protection, income splitting, or family wealth planning — the Family Trust Election (FTE) under section 272-80 of Schedule 2F to the Income Tax Assessment Act 1936 is one of the most consequential and least understood features of the structure. An FTE is a formal declaration that the trust will be treated as a "family trust" for income tax purposes, built around a nominated test individual (the legislation calls them the "primary individual") and the family group defined around that person. The election unlocks valuable concessions — the ability to recoup trust losses, to pass franking credits through to beneficiaries, and to help related companies meet their loss-continuity tests — but it imposes a permanent restriction: any distribution outside the family group attracts Family Trust Distribution Tax (FTDT) at the top marginal rate plus the Medicare levy, 47%. For retirees managing trusts whose family configuration has shifted through marriages, divorces, deaths and successions, the family group is not a frozen feature from the trust's establishment — it is a live question that good planning keeps under review.

The purpose of an FTE is to access specific concessions. For a discretionary trust holding shares that pay franked dividends, the franking credits can only flow through to beneficiaries — and ultimately become refundable to retirees in pension phase — if the beneficiaries are "qualified persons," which broadly requires either that the trust has made an FTE or that the shares were held "at risk" for the 45-day holding period (90 days for certain preference shares). There is a limited carve-out: an individual whose total franking tax offset for the year is $5,000 or less is a small shareholder exempt from the holding-period rule, but above that level the FTE is effectively the practical route. The election also lets a trust recoup carry-forward losses without running the full battery of trust-loss integrity tests (the income injection, pattern of distributions and control tests) each year. For most family discretionary trusts of any substance — especially those holding franked-dividend-paying Australian shares — making an FTE is close to essential to extracting the structure's full tax value.

The test individual sits at the centre of the election. The trustee nominates a single person — usually the controller or principal beneficiary — who must be alive at the time the election is made, and the family group is then defined by reference to that person. Once nominated, the test individual can generally be varied only once, and only to someone who was a member of the original test individual's family at the relevant time, subject to strict conditions. For a trust that has been running for decades, the original FTE — perhaps made in the 1990s by an accountant long since retired — may name a test individual who is no longer the active controller, or who has died. Locating the FTE record (usually filed with the trust's tax returns and accounting papers) and confirming who the test individual is must be the first step of any modern review.

The family group is defined in section 272-90, and the test individual's family — the core of that group — in section 272-95. The family takes in the test individual, their spouse, and the parents, grandparents, brothers, sisters, nephews, nieces and children (and lineal descendants of those children, nephews and nieces) of either the test individual or the test individual's spouse, plus the spouses of all those people. The wider family group adds the trust itself and any company, partnership or other trust brought in by an interposed entity election, along with certain charities. For most families this captures the everyday recipients of family wealth — the controller, their spouse, their children and grandchildren, those people's spouses, and siblings and their families. But the edges are sharper than people expect: cousins, aunts and uncles fall outside the group, and the relatives of a sibling's spouse generally do too. Importantly, the group is built to survive relationship change — the definition expressly continues to include a former spouse, a former widow or widower, and a former stepchild, so divorce or the death of the person through whom someone qualified does not, by itself, eject them from the group.

The Family Trust Distribution Tax is the integrity measure that enforces the restriction. A distribution of trust income or capital — or a conferral of present entitlement — to anyone outside the family group attracts FTDT at 47%, and the trustee is primarily liable (with the recipient secondarily liable), so it is the trust's own assets that fund the tax. The effect can be brutal: a trustee who distributes $50,000 to a long-time family friend in a gesture of generosity can see the trust pay $23,500 of FTDT on top, so the $50,000 gift effectively costs $73,500. The trap is not limited to obvious cash gifts — a loan from the trust to a non-family-group member, or that person's rent-free use of a trust asset, can be treated as a constructive distribution and taxed the same way.

The interposed entity election is the companion tool for multi-entity structures. Where a family invests through layers — say, a discretionary trust that owns shares in a "bucket company" corporate beneficiary holding the portfolio — an FTE over the trust alone is not enough. The bucket company needs its own interposed entity election (under section 272-85) naming the same test individual, which makes it a member of the family group so that income or capital can move between it and the trust without triggering FTDT. A common and expensive error is a trust with a valid FTE sitting alongside a related company that never made an IEE — at which point distributions involving that company become exposed. Reviewing the election position across every related entity is essential for families who have built up structured holdings over the years, and it sits alongside the Division 7A questions that arise when money is drawn from such a company.

A final, long-horizon issue is the vesting day. Family trusts established under the common 80-year perpetuity period (still in force in most states, though South Australia has abolished the rule against perpetuities) have a fixed vesting date at which all assets must be distributed. Trusts created in the 1960s and 1970s vest in the 2040s and 2050s — squarely within the planning horizon of today's retirees — and any vesting distribution to beneficiaries outside the family group triggers FTDT. Where a trust's intended terminal beneficiaries include non-DGR charities or people outside the group, the vesting event needs to be planned years ahead, and may call for a deed variation to extend the vesting day or substitute eligible beneficiaries.

What do worked planning examples show?

These two cases show how FTE issues affect retirement-phase trust management. Illustrative only — not personal advice — using FY25-26 figures.

Case 1 — David, 71, retired. His family discretionary trust was set up in 1998 with an FTE naming David as the test individual. It holds a $1.2M share portfolio paying about $48,000 a year in franked dividends. David has two adult children (both married, with children of their own) and one step-daughter — his current wife's daughter from a prior relationship — and he distributes trust income across all three "children" each year. On these facts, the FTE lets the portfolio's franking credits flow through to the beneficiaries, valuable for David's adult children who use the credits in their own returns. The step-daughter is comfortably inside the family group: she is a "child of the test individual's spouse" under section 272-95, so distributions to her are valid. And because the family group definition expressly preserves a former stepchild, she would remain in the group even if David's wife predeceased him — so those distributions stay valid. On these facts the rational steps are to confirm the FTE record, document the relationships clearly for the trustee's file, and address the next generation explicitly in succession planning, since the further the family tree extends, the more carefully each branch must be checked against the group.

Case 2 — Sandra, 73, retired. Her family discretionary trust was established by her late husband in 1985; she became trustee in 2012 when he died. No FTE was ever made. The trust holds about $800,000 of investment property and shares, and the accountant has spent years wrestling with the trust-loss integrity tests and unable to pass franking credits through cleanly. On these facts the trust is leaving real money on the table — losses go unrecouped in many years and franking credits don't flow through. Making an FTE now (naming Sandra, or perhaps her son, as test individual) would fix both going forward, at the price of locking all future distributions inside the family group. On these facts, given Sandra's age and the trust's likely remaining life, the franking-credit pass-through and loss recoupment over the next 10–20 years will usually outweigh any FTDT risk provided every intended beneficiary is within the immediate family. The rational approach is to weigh that trade-off explicitly, make the FTE if the numbers favour it, map the family group, and align the will and estate plan with the group so no well-meant future distribution lands outside it.

For retirees with family discretionary trusts, the FTE materially shapes both the trust's tax efficiency and the safety of passing wealth down the generations. The advice work is to confirm whether an FTE exists, identify the test individual, map the family group explicitly (remembering that former spouses and former stepchildren stay in, but cousins and in-laws' relatives do not), verify interposed entity elections for any related companies, run a family-group check before every distribution, align the estate plan with the group, and plan vesting-day timing for older trusts. The 47% Family Trust Distribution Tax is a genuine penalty that careful planning avoids — but only by treating the family group as a current question rather than a relic of the trust's establishment decades ago. Where distributions to a low-rate beneficiary are not genuinely for that person, the separate section 100A reimbursement-agreement rules can also bite.

Sources

• Australian Taxation Office (ATO) — Family trusts
• Australian Taxation Office (ATO) — Family trust distributions tax what you need to know
• Australian Taxation Office (ATO) — Document
• Australian Taxation Office (ATO) — Non widely held trusts and the franking tax offset
• Australian Taxation Office (ATO) — Refund of franking credits for individuals