StreetSmart Group, Accounting, Chartered Accountants, Business Advisors, Auckland, New Zealand

Do I need a family trust? What are the pros and cons?

A trust is a legal structure where the person setting it up (settlor) settles assets and property, which are to be applied for the benefit of beneficiaries. But trust assets are owned and managed by trustees on behalf of the beneficiaries. There are generally one or two settlors for each trust, two or more trustees often including an independent trustee (who is not a beneficiary), and a number of beneficiaries such as your children, grandchildren and other relatives. Beneficiaries can be people as yet unknown by name (such as future children or grandchildren, or a future spouse). It is possible to add discretionary beneficiaries at a later date, although not “final” beneficiaries. You probably need a trust if: You own assets and want to ensure that when you die your assets are protected and go to your loved ones as you intended You have a business and want to protect your home and other assets from creditors or the risk of business failure You want to protect your assets from the possibility of being personally sued You want to ensure you are eligible for rest home subsidies in your old age You want to ensure that if estate duty, death duties or capital gains tax is introduced you are protected as much as possible You want to protect yourself or your children from financial loss due to relationship failures You wish to minimize your personal income for some reason, such as being eligible for a means tested government grant or minimizing income for child support purposes. Tax efficiencies are important to you. Tax laws are constantly changing and we do not recommend using a trust solely for tax savings. However, a trust can offer some flexibility to tax planning and can in some instances help to minimize tax. In the past many trusts were set up that were inflexible and cumbersome. However, modern trusts are much more flexible, and if well set up should serve their purpose without too many down sides. A trust can run for up to 80 years before it must be closed and the assets distributed to beneficiaries. However, the trustees can decide to wind up the trust before the 80 years have elapsed. Generally the trust will run for the life of the settler / settlors. But once the settlors have died and the beneficiaries are “of age” the trust would usually be distributed to the beneficiaries. Modern trusts can be set up to ensure that when the distributions are made that they go direct to new trusts set up by the beneficiaries themselves. This adds an extra layer of protection and eliminates the need for the beneficiaries to gift their inheritance to their own trust. Most trusts used today are “discretionary” which means that decisions are made at the discretion of the trustees. This is a key advantage over leaving assets by way of will, as it is often difficult to foresee future events. If an estate is distributed by way of will there is little flexibility available to executors. However, trustees of a discretionary trust have much flexibility available to them that they can utilise to gain the best outcomes for beneficiaries. For example, if a beneficiary is facing business or relationship failure the trustees of a trust would usually be able to delay a trust distribution to a more suitable time whereas the executors of a deceased estate may not be able to do this. Be aware that when you set up your trust you should update your wills at the same time to ensure that on your death your assets are distributed directly to the trust. Under existing NZ tax law an individual can only gift $27,000 per annum tax free. If more than this is gifted then gift duty is payable. Furthermore, transactions between “associated parties” must be made at market value. This means you cannot value your home at say $1,000 and give it directly to your trust without incurring gift duty. Instead, you would need to formally value your home and sell it to your trust at market value. As part of the sale agreement you would “loan” the trust the equity in the house. You would then progressively gift $27,000 of the loan to the trust each year. Obviously, this can take many years and that is the reason why we recommend setting up a trust as early as possible. For example, let’s assume your family home is currently worth $540,000. If you and your spouse decide to set up a trust and then sell the home to the trust for $540,000, the trust will end up owing each of you $270,000. You would then commence a gifting programme (your accountant or lawyer usually handles this) and after 10 years the loan would be fully gifted. At that point it is likely that your home would be worth perhaps $1m. Even if that is the case the trust now owns the home outright, and the capital growth in the value over the 10 years now belongs to the trust. Many people ask, “But what happens if I want to sell that home and buy another one?”. There is no difficulty here so long as the trustees agree. In that case the trustees would put the existing home on the market, sell it and then purchase a new home – just like you would if you if you owned the home personally. But a word of warning here… all trustees are obligated to make decisions that are in the best interests of the beneficiaries. So while you may be personally prepared to take a few risks and perhaps stretch yourselves financially, trustees cannot usually agree to do so if it would put the beneficiaries at risk of loss. There is a “prudent person” test – what would a prudent person do in those circumstances? This can become an issue when the settlors want to borrow against a trust asset to invest in a medium to high risk investment, such as the family business. If the independent trustee felt that the risks were too high they would either have to veto the decision or resign as trustee. This is one of the possible downsides of having a trust. Although, it can also be a potential upside as the independent trustee is often more business savvy and prudent that the other trustees who have an emotional or vested interest. In any case, usually the trust deed will give effective control of the trust to the settlors by way of a “Power of Appointment of Trustees”. In a situation such as that mentioned above, the person or people with the power of appointment would be able to remove any trustee if they wished. So in effect, if the trust deed is properly set up you are indirectly still in control of your trust and the trust assets if you hold the power of appointment of trustees. There is no law stipulating that a trust must have an independent trustee, but we strongly recommend it. Ideally the independent trustee will be a professional advisor with a good working knowledge of business, tax and trust law (as opposed to a friend who can add limited value to decision making and is more inclined to rubber stamp decisions). Assuming that an appropriate person has been selected to be independent trustee, then the advantages of having an independent trustee include: Better decision making, as all major transactions will require the consent and signature of the independent trustee Good trust administration processes, as the independent trustee should be aware of the need for regular meetings, review of trust assets and liabilities and documentation required for trustee decisions. The disadvantages of having an independent trustee usually relate to additional costs and the inconvenience of having to consult with a third party about trust decisions. However, we believe that the benefits outweigh the costs in most cases. A word of warning here – just because you have a trust does not mean that your assets are secure. You also need to ensure that the trust is properly administered so it cannot be challenged by say creditors or a disgruntled family member at a later date. IRD can also challenge your trust if they believe it is a “sham”, which would probably be the case if you were using the trust assets as if they were your personal assets. So in summary, a trust can be an excellent medium to long term estate planning and asset protection tool. But setting up the trust is just the first step. To really maximize the value of having a trust it must be maintained and looked after, just like the assets and investments that the trust owns. The real benefits of having a trust are usually in the future, when something in your life goes wrong. We strongly recommend that you discuss setting up a trust or how to best maintain your existing trust with your StreetSMART advisor.

A trust is a legal structure where the person setting it up (settlor) settles assets and property, which are to be applied for the benefit of beneficiaries. But trust assets are owned and managed by trustees on behalf of the beneficiaries.

There are generally one or two settlors for each trust, two or more trustees often including an independent trustee (who is not a beneficiary), and a number of beneficiaries such as your children, grandchildren and other relatives. Beneficiaries can be people as yet unknown by name (such as future children or grandchildren, or a future spouse). It is possible to add discretionary beneficiaries at a later date, although not “final” beneficiaries.

You probably need a trust if:

You own assets and want to ensure that when you die your assets are protected and go to your loved ones as you intended
You have a business and want to protect your home and other assets from creditors or the risk of business failure
You want to protect your assets from the possibility of being personally sued
You want to ensure you are eligible for rest home subsidies in your old age
You want to ensure that if estate duty, death duties or capital gains tax is introduced you are protected as much as possible
You want to protect yourself or your children from financial loss due to relationship failures
You wish to minimize your personal income for some reason, such as being eligible for a means tested government grant or minimizing income for child support purposes.
Tax efficiencies are important to you. Tax laws are constantly changing and we do not recommend using a trust solely for tax savings. However, a trust can offer some flexibility to tax planning and can in some instances help to minimize tax.

In the past many trusts were set up that were inflexible and cumbersome. However, modern trusts are much more flexible, and if well set up should serve their purpose without too many down sides.

A trust can run for up to 80 years before it must be closed and the assets distributed to beneficiaries. However, the trustees can decide to wind up the trust before the 80 years have elapsed. Generally the trust will run for the life of the settler / settlors. But once the settlors have died and the beneficiaries are “of age” the trust would usually be distributed to the beneficiaries.

Modern trusts can be set up to ensure that when the distributions are made that they go direct to new trusts set up by the beneficiaries themselves. This adds an extra layer of protection and eliminates the need for the beneficiaries to gift their inheritance to their own trust.

Most trusts used today are “discretionary” which means that decisions are made at the discretion of the trustees. This is a key advantage over leaving assets by way of will, as it is often difficult to foresee future events. If an estate is distributed by way of will there is little flexibility available to executors. However, trustees of a discretionary trust have much flexibility available to them that they can utilise to gain the best outcomes for beneficiaries. For example, if a beneficiary is facing business or relationship failure the trustees of a trust would usually be able to delay a trust distribution to a more suitable time whereas the executors of a deceased estate may not be able to do this.

Be aware that when you set up your trust you should update your wills at the same time to ensure that on your death your assets are distributed directly to the trust.

Under existing NZ tax law an individual can only gift $27,000 per annum tax free. If more than this is gifted then gift duty is payable. Furthermore, transactions between “associated parties” must be made at market value. This means you cannot value your home at say $1,000 and give it directly to your trust without incurring gift duty.

Instead, you would need to formally value your home and sell it to your trust at market value. As part of the sale agreement you would “loan” the trust the equity in the house. You would then progressively gift $27,000 of the loan to the trust each year. Obviously, this can take many years and that is the reason why we recommend setting up a trust as early as possible.

For example, let’s assume your family home is currently worth $540,000. If you and your spouse decide to set up a trust and then sell the home to the trust for $540,000, the trust will end up owing each of you $270,000. You would then commence a gifting programme (your accountant or lawyer usually handles this) and after 10 years the loan would be fully gifted. At that point it is likely that your home would be worth perhaps $1m. Even if that is the case the trust now owns the home outright, and the capital growth in the value over the 10 years now belongs to the trust.

Many people ask, “But what happens if I want to sell that home and buy another one?”. There is no difficulty here so long as the trustees agree. In that case the trustees would put the existing home on the market, sell it and then purchase a new home – just like you would if you if you owned the home personally.

But a word of warning here… all trustees are obligated to make decisions that are in the best interests of the beneficiaries. So while you may be personally prepared to take a few risks and perhaps stretch yourselves financially, trustees cannot usually agree to do so if it would put the beneficiaries at risk of loss. There is a “prudent person” test – what would a prudent person do in those circumstances?

This can become an issue when the settlors want to borrow against a trust asset to invest in a medium to high risk investment, such as the family business. If the independent trustee felt that the risks were too high they would either have to veto the decision or resign as trustee. This is one of the possible downsides of having a trust. Although, it can also be a potential upside as the independent trustee is often more business savvy and prudent that the other trustees who have an emotional or vested interest.
In any case, usually the trust deed will give effective control of the trust to the settlors by way of a “Power of Appointment of Trustees”. In a situation such as that mentioned above, the person or people with the power of appointment would be able to remove any trustee if they wished. So in effect, if the trust deed is properly set up you are indirectly still in control of your trust and the trust assets if you hold the power of appointment of trustees.

There is no law stipulating that a trust must have an independent trustee, but we strongly recommend it. Ideally the independent trustee will be a professional advisor with a good working knowledge of business, tax and trust law (as opposed to a friend who can add limited value to decision making and is more inclined to rubber stamp decisions).

Assuming that an appropriate person has been selected to be independent trustee, then the advantages of having an independent trustee include:

Better decision making, as all major transactions will require the consent and signature of the independent trustee
Good trust administration processes, as the independent trustee should be aware of the need for regular meetings, review of trust assets and liabilities and documentation required for trustee decisions.

The disadvantages of having an independent trustee usually relate to additional costs and the inconvenience of having to consult with a third party about trust decisions. However, we believe that the benefits outweigh the costs in most cases.

A word of warning here – just because you have a trust does not mean that your assets are secure. You also need to ensure that the trust is properly administered so it cannot be challenged by say creditors or a disgruntled family member at a later date. IRD can also challenge your trust if they believe it is a “sham”, which would probably be the case if you were using the trust assets as if they were your personal assets.

So in summary, a trust can be an excellent medium to long term estate planning and asset protection tool. But setting up the trust is just the first step. To really maximize the value of having a trust it must be maintained and looked after, just like the assets and investments that the trust owns. The real benefits of having a trust are usually in the future, when something in your life goes wrong. We strongly recommend that you discuss setting up a trust or how to best maintain your existing trust with your StreetSMART advisor.

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