Trusts are building blocks for Asset Planning...
...but only if you know how they work
New Zealand families have created more trust deeds per capita than most countries, but do the people using them really understand what a Family Trust is and what it can do? If you don't, your trust may not be as effective as you think.
This article will hopefully help to shed some light for you.
TRUSTS IN PLAIN ENGLISH
What does a family trust do?
The idea with a family trust is to protect the ownership of your assets. Here’s how trusts work: you transfer the legal ownership of your assets to the trustees while continuing to use and enjoy them as long as the trust deed permits. For example, if your family home is in a trust, you no longer personally own the house – but you can still live in it if that’s what the trust deed allows and the trustees agree.
Benefits of a family trust
Family trusts are designed to protect your assets and benefit members of your family beyond your lifetime. When your assets are in a family trust you no longer have legal ownership of them – the assets are owned by the trustees, for the benefit of your family members.
People usually set up a family trust to get some benefit from no longer personally owning an asset. A family trust may be useful to:
A settlor: The person or company who creates the trust.
Appointor: The Appointor is the person who can appoint or remove Trustees. This is usually the settlor but it can be someone nominated by the settlor. It is important that the Appointor always has someone nominated to replace themselves if they can no longer do the job.
Trustees: The people who manage the trust. The settlor can also be a trustee. It’s also a good idea to appoint an independent trustee who is not a beneficiary. Professionals like lawyers and accountants (or companies they have set up) often act as independent trustees. Your Trustees need to be people you trust to administer the Trust properly and fairly.
Beneficiaries: The people who benefit from the trust, for example members of immediate family.
Guardian: This person has certain powers to keep an eye on a trust’s operation. Where a trust deed provides for a guardian, it will usually require that the Trustees obtain consent from the Guardian before major decisions are made. Often the Appointor and the Guardian may be one and the same person but there are sometimes very good reasons to make those people different.
Special Trust Advisor (previously called an Advisory Trustee): This person advises the Trustees but is not a Trustee and cannot compel the Trustee.Most Family Trusts will not require a Special Trust Advisor, but with an increasing tendency to outsource financial advice there is likely to be an increase in the number of trust deeds involving one.
How long does a Family Trust last?
A trust doesn’t usually end with the settlor’s death – that is one of the main reasons that trusts are created. A trust usually lasts for a maximum of 80 years from inception but as of January 2021 that can be extended to 125 years.
How family trusts work
A legal document called a ‘trust deed’ will formally set up the family trust. It will name the trustees, list the beneficiaries, and state various rules for the administration and management of the trust. The trust deed needs to be very carefully written. The “one size fits all” trust deed will fit as well as badly as most items with that label.
After you have your trust deed prepared, you need to decide what things you own will go into the family trust, and what their value is. In many cases this will be the family home, but other things of value like cash, bank deposits, shares, artwork etc can also be included in the trust.
Once the family trust is formed assets can be sold into the trust, at market value. This is where it can get a little tricky. Although the trust wants to buy, say, your house (and you want to sell it to the trust) the trust may have no money to buy it. How then does the family trust pay for the house?
The answer to this is that you lend the family trust the money. Initially this is a ‘paper’ transaction – you sell the house to the trust, and the trust owes you a debt. However, the debt that the trust owes you is still counted as a personal asset. So you will need to get rid of the debt so you can achieve your aim of owning less in your name.
The way you do this is through ‘gifting’.
Most people who form trusts ‘gift’ away the debt that the trust owes them. IN In New Zealand, before October 2011 there was a limit of $27,000 that anyone could gift in one year without paying a tax called ‘gift duty’ to Inland Revenue. However, gift duty has been abolished and there is no limit to how much you can gift in one year. This means that where previously it would have taken 22 years to gift the value of a house worth $600,000 to a family trust without paying gift duty, you can now gift the whole amount of the debt straight away.
However, the decision of what to gift and when should be considered carefully after receiving legal and financial advice.
Note that gifts are still included in the assessment for a Residential Care Subsidy.
Family trusts can be complex and time consuming to administer. It costs money to set them up and there are generally ongoing (at least, annual) legal and accounting fees.
If a trust is not set up or managed well, there can be considerable inconvenience and cost.
There’s the risk of having the trust declared a ‘sham’, which would mean that the assets are not really the trustees’ but are in fact still yours. If the trust is declared a sham you may lose all of the advantages that you were hoping to gain from it, and the trustees may be penalised as well.
Once you put your assets into a trust, you no longer personally own or control them. Instead, ownership passes to the appointed trustees, who must act under the terms of the trust deed in the best interests of the beneficiaries.
There have been cases of family members suing other family members for a breach of the trust’s provisions. The courts treat claims of this sort quite seriously and they will normally be expensive to resolve.
Forming a trust is a big decision. When going down this route, make sure that it is established properly, for the right reasons, and managed well. Keeping clear records of everything that affects the trust is very important.
Trusts are complex. Legal advice is essential. Accounting advice is also recommended. This article talks about Trusts in New Zealand and there can be significant differences in the way trusts can operate from country to country.
This article is for information only and should not be relied on as legal advice.
Note from the Author
I get plenty of time to think about legal matters while I am on the road.
This blog shares those thoughts and also answers some of the many questions people ask me. Hopefully there is something of interest to you. If there is a subject you would like covered then let me know!
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