Here is some basic information to help you consider how a Trust might work in your particular situation.
What is a Trust?
A Trust is a separate legal entity which has a life of its own.
A Trust has three participants:
- The Settlor – the persons who initially transfer property to a Trust.
- The Trustees – the Trustees hold the property of the Trust and are responsible for dealing with that property in accordance with the Trust Deed. It does not matter legally, who the Trustees are, so long as they have the legal capacity to act as Trustees. It is most common however for the Trustees to be the people wishing to set up the Trust quite often together with an independent third party such as a solicitor, accountant or close family member.
- The Beneficiaries – these are the people who, at the discretion of the Trustees, are entitled to receive a benefit under the Trust. The beneficiaries will normally comprise the husband and wife, children and their descendants. Depending on circumstances, other family members or relatives may also be included.
The Trust Deed identifies the Settlor, Trustees and Beneficiaries; sets out the powers of the Trustees and generally lays down the ground rules for the Trust. A Trust may well exist for a long period of time and thus it is vital that the Trust Deed is flexible enough to cover changing circumstances over time.
Most trusts commonly being used today are called discretionary trusts. This term is used because although the Trust Deed will nominate certain classes of beneficiaries, the Trustees have a discretion as to which of the beneficiaries will receive a benefit under the Trust. Discretionary trusts allow maximum flexibility with no absolute requirement for the Trustees to distribute trust assets to any particular beneficiary. Consequently no beneficiary can claim an absolute entitlement to any particular trust asset.
The Trustees not only have a discretion as to which of the beneficiaries benefit, but also as to when any distributions are made from the Trust. Under the Trustee Act however, the Trustees are required to exercise their discretion prudently, and always act in the best interests of the beneficiaries. The maximum period that a trust usually exists for is 80 years due to a legal requirement called the Perpetuities Rule.
How is property transferred to a Trust?
Signing a Trust Deed does not achieve anything on its own. To have any impact a trust has to obtain assets which the Trustees then look after on the terms set out in the Trust Deed.
A common example of the way this occurs is where a husband and wife form a family trust and then transfer assets such as their family home, investment property, holiday home, shares or investments to the Trust.
The Trust acquires the assets from the husband and wife, and this is normally done by way of a sale and purchase at current market value. But because the Trust has no funds it effectively “borrows” the amount needed to pay for the assets from the husband and wife, and this amount is recorded as a debt owed by the Trust to them.
Traditionally this debt was “gifted” to the Trust by the husband and wife agreeing to reduce the amount owed to them by the Trust by $27,000.00 per year each. This was historically the amount that could be gifted without paying gift duty, but since gift duty was abolished on 1 October 2011 it is now possible to foregive the entire debt owed by the Trust at once.
Whether that is the best thing to do or not is an important decision.
If you foregive the entire debt at once, that decision will be subject to any possible clawbacks – for example if a creditor considers that assets were transferred to the Trust to avoid the need to pay creditors, it may be clawed back, meaning it would still be treated as your asset individually, and thereby exposed to creditor claims against you personally. The same can apply for relationship property claims and applications for rest home subsidies.
So our view is that there is a need to carefully document the reasons for the Trust, plus all transactions and administrative matters involving the Trust will need to be accurately recorded.
The mechanics of transferring a property to a Trust
The actual mechanics of transferring property to a trust are as follows:
- The property is transferred by you to the Trustees (often yourselves plus an independent trustee appointed by you).The property would be transferred at valuation.
- The Trustees ‘borrow’ from you the amount at which the property is so transferred.
- That lending would be formally recorded (the Trustees acknowledging that they owe the particular amount) with you embarking on a gifting programme to gift off the debt the Trustees owe you either gradually (as has been the general practice in the past) or at once. Your choice of action here will depend on your own circumstances and an assessment of the risks of clawback.
- With regard to any mortgage which you have over the property a fresh mortgage from the Trust (on the same terms as your existing one) will generally be required by the Bank as well as a Guarantee from you to link the Trust property to your loan with the Bank.
What can the setting up of a Trust achieve?
The benefits of establishing a Trust are many and varied. Each person’s situation will be different, and hence their reasons for establishing a Trust will also differ. For example:
- protection against creditors or claimants against your business or against you personally. A trust can effectively protect your asset base by creating a “firebreak” between your personal assets and your business affairs;
- a desire to provide for simpler succession planning for future generations;
- a desire to protect your own children from the possibility of losing assets should they enter a de facto or marriage relationship which turns sour;
- a tool for improving tax efficiency in limited circumstances;
- protection against relationship risks of your own;
- protection if you are applying for some sort of benefit which is subject to asset-testing;
- protection against the possibility of estate duties being re-introduced in some form.
Under discretionary trusts the property is legally owned by the Trustees, but because they hold the assets of the Trust on behalf of the beneficiaries, the Trust property does not provide a benefit to the Trustees in their own right.
Because the beneficiaries are discretionary beneficiaries, they do not have any rights of ownership in the Trust property prior to the final termination date either, except to the extent that the Trustees may decide.
Therefore the Trust property is held in a state of limbo with the result that it does not form part of the estate or assets of any person. This means that assets held by a family trust will normally be protected from a wide range of risks that an individual might face. These are as follows:
Creditors and Business Risk
When people decide to embark on a business venture they normally allocate money towards that venture and in doing so they recognise that there is a calculated risk in that if the venture fails the money that they have put into it is at risk.
Unfortunately sometimes business failures expose other assets to risk which an individual does not wish to have exposed. For example, the family home, holiday home, personal savings, investments and superannuation. By having some or all of these assets held in a family trust they will not be lost if a business venture fails or if there is a claim against the individual due to something like a guarantee that an individual has entered into for bank borrowing or the personal guarantee of a lease.
The use of a Trust in these circumstances allows an individual to separate domestic or private assets (that the individual does not want to place at risk), from business assets which an individual will recognise as being part and parcel of the business venture and therefore exposed to risk.
A number of people, particularly the elderly, use trusts as a defence against asset testing. A government subsidy (Rest Home subsidy) is available to people over the age of 65 years who require long term Rest Home care. Eligibility for the subsidy is asset tested.
Assets held in a trust which has been set up properly are not currently taken into account when applying for a Rest Home subsidy, with one extremely important exception. Presently any gifts made within five years of a subsidy application (e.g. those reducing debts owed by family trusts) can be “clawed back” into a person’s asset pool for the purposes of the asset test. It is for this reason that it is possible to leave the setting up of a family trust too late as regards its usefulness for avoiding assets testing.
Obviously with annual Rest Home charges at current levels it would not take long for a hard earned nest egg to be dissipated. Clearly then a properly set up and well planned family trust can provide an effective protection for this nest egg.
It must be stressed that there is a high rate of legislative change in this area and it is therefore not possible to guarantee that the use of a trust is always going to provide effective protection against asset testing.
Estate Duty was abolished for the estate of any person who died after 17 December 1992. Prior to that time estate duty was payable on the value of an estate valued in excess of $450,000.00. Prior to the abolition of estate duty family trusts were a common estate planning technique to ensure that on death, estate duty was avoided or at least minimised.
Some of the political parties have indicated that they would possibly reintroduce estate duty if they were in government. It is possible that in those circumstances trusts would again be an effective means of avoiding estate duty.
In the past marginal tax rates ranged from between 15% to 66%. The ability to split income by transferring income producing assets to a trust was extremely attractive and was a common technique for minimising tax. The incentive to use trusts in this way has reduced as the tax scale has flattened.
Personal tax rates now vary between 10.5% and 33% so the advantage in using trusts as an income splitting device is less significant. Nevertheless there can still be advantages achieved by the trust distributing income it receives to various beneficiaries. Those beneficiaries (rather than the trust) are then liable to pay the tax on the income. Of course the individual beneficiaries may be on a lower tax rate than the original settlor would have been if he/she had received the income him/herself, and thus overall income tax liability on the income is reduced. If income is left in the Trust, it will be taxed at a flat rate of 33%.
Estate Planning and Protection from Claims
The use of trusts for estate planning is one of the less fashionable and often forgotten benefits of a family trust. Most people overlook the fact that when they die a trust is created. Under a Will property is left to trustees to distribute to the beneficiaries named in the Will. Use of a family trust can bring this process forward so that it occurs during a person’s lifetime rather than after their death when, for obvious reasons, they have little control over what is happening.
Use of a family trust can ensure that a person can see the orderly transfer of their wealth to the next generation during their lifetime while at the same time they can still exercise some control over the asset through the Trust. In this way a person can avoid claims under the Family Protection Act and gain some protection against claims under the Property (Relationships) Act. Most people will be aware that on a person’s death a disappointed family member can bring a claim under the Family Protection Act against whatever assets there are in a deceased estate.
If assets have been distributed to a beneficiary of a family trust then such claims may well be avoided or at least minimised. In a similar way a child who receives a benefit under a Will may find that a claim is made by the child’s spouse for a half share of the inheritance. Once again use of a family trust can provide some protection against such claims if that is considered appropriate.
As with estate duties, it is possible that some form of asset/income testing for National Superannuation eligibility could be reintroduced at any time. By having assets owned by a Family Trust (which results in the income off those assets also being paid to the Family Trust) in advance of any such test being applied, protection is gained against “savings taxes” such as the surcharge. Funds can still be obtained from the trust however, by way of capital distributions which do not affect any income test.
Are there any disadvantages in setting up a Trust?
A trust is a separate legal entity, so technically, once you transfer property to a trust it no longer belongs to you. This is the reason that it has the advantages that have already been outlined.
Because the property no longer belongs to you there are new and important considerations to take into account when dealing with the property. Although you can be a beneficiary/trustee and thereby exercise substantial “de facto” control over the assets, you have a “fiduciary duty” to consider the requirements of all the trust beneficiaries in dealings with the trust property. Making sure that these duties are met is essential to the Trust being able to stand up to any form of legal challenge.
What is involved in setting up a Trust?
Essentially anyone thinking about setting up a trust should seek professional advice. Usually these advisors will be a person’s solicitor, accountant and where appropriate financial planner. Each of these advisors have special areas of expertise and their involvement will ensure that your objectives are met.
What are the ongoing requirements for operating a Trust?
Once a trust is established it must be operated correctly otherwise the benefits could be lost. You cannot simply set up a trust, transfer some property into it and then forget about it, keep no records and simply treat the property as if it was still your own. Proper records must be kept about all transactions and the administration of the Trust. Remember on all occasions that the trust is a separate legal entity.
The Trust will require its own IRD number and where appropriate (depending on the level of taxable activity the Trust carries out) a GST number. Decisions made by the Trustees should be properly documented and a minute book maintained. Separate bank accounts may need to be established and a separate set of overall accounting records for the Trust should also be considered. In most cases where the Trust is used to hold non-trading assets such as property or investments the record keeping will be simple.
Queenstown Law is able to give professional advice in relation to whether a Trust is appropriate for your circumstances, actually forming the Trust, and then correctly administering the Trust so that it serves the purposes intended and doesn’t come unstuck.
Please contact us on 03-4500000 or email