To Trust, or not to Trust?

Have you ever considered establishing your own family trust, but didn't know where to start, or if it was even necessary?  Dominique Fourie, a solicitor with AWS Legal, looks at the advantages and disadvantages of family trusts.

The formation of family trusts is a practice that is becoming increasingly common for family units, individuals and entrepreneurs alike.  Gone are the days when family trusts were used only by the wealthy.  Today, trusts are seen as working tools which can help protect your property from third party claimants.  According to the 2006 census, over 170,000 homeowners had transferred their major asset, their family home, into a family trust.  So there must be something to it.

Trusts come in all shapes and sizes.  Each trust is different, tailor-made to suit the specific needs of you and your family.  Trusts may not be necessary for everyone, but the growing number of family trusts suggests that people are becoming increasingly aware of their advantages.  People are beginning to establish trusts earlier in their lives, for the purpose of obtaining maximum benefit from the protection they offer. If you own assets, are in a serious relationship, have children or own your own business, then setting up a family trust is certainly something you should investigate.

What is a trust?

A trust is a formal arrangement between parties, whereby one party gives control of their assets to another party, to hold for the benefit of specific people.  A trust is a relationship between all the parties involved, and can be set up at any time, by any person.

Getting started

There are three positions necessary to establish a trust.

1. The settlor.  This is the person who establishes the trust, and transfers at least a low-valued asset into the trust so that the trust is formally established.  Other assets can be transferred later, whether by the settlor or by other persons.  The settlor can be one person individually, or more than one person, such as a married couple.
2. The trustees.  These are the people the settlor has chosen to have legal control over the assets in the trust.  Usually the trustees would include relatives, close friends, and often an independent third person, possibly a lawyer or accountant.  Trustees act as the guardians of the assets in the trust.  They have the final say on what happens to the assets in the trust, and they control the distribution of those assets according to the terms of the trust.  A settlor can also be a trustee.  Depending on the terms of the trust, you may be able to appoint replacement trustees - people who will replace you as a trustee when you pass away.
3. The beneficiaries.  These are the persons the settlor has chosen to benefit from the assets in the trust.  The trustees hold the assets ‘on trust' in their names for the benefit of the beneficiaries.  Again, the settlor and any of the trustees can, and often are also named as beneficiaries.

All of this information is recorded in a trust deed.  This is the foundation document in the process of setting up your trust.  It is carefully drafted by your lawyer, and formalises the creation of the trust.  The trust deed includes the details of the mechanics of the trust - it explains in detail the obligations the trustees are under to administer the trust and outlines how they are to make their decisions.  Once you have  chosen a name for your trust (you really have free rein here), and once the trust deed has been signed by the settlor and the trustees, the trust has then been established.

Advantages of establishing a trust

There are many benefits to establishing a trust for you and your family.

Creditor protection

When you transfer assets into a trust, you no longer own those assets personally, although you maintain control of them through your role as trustee of the trust.  Transferring your personal assets to the trust is known as creating ‘personal poverty' - and it's not as awful as it sounds.  It means that you no longer have personal assets in your name which can be claimed by creditors.  These assets are now owned by the trust.  This is of particular benefit to small business owners, who may have had to sign personal guarantees for lending when first establishing their business.  To transfer land, consent of your mortgagee is usually required.  Note that you can't set up a trust if it has the effect of avoiding your shortterm creditors, however in the longer term, creditor protection is one of the major advantages of establishing a family trust, and your Lawlink lawyer can discuss this in further detail with you. 

Relationship property claims

If you transfer your assets into a family trust before you enter into a relationship, your new partner will have no claim on these assets if your relationship ends.  However, if you are already married, or in a de facto relationship, then it is likely that the majority of your assets will be classed as ‘relationship property'.  In New Zealand, there is a 50-50 presumption when it comes to splitting the assets when a relationship ends.  However, any assets that you have already transferred to the trust belong to the trust, and do not form part of your personal assets.  This means that those assets are protected from the 50-50 division of assets in New Zealand law, but you need to note that a Family Court may, on the breakup of a marriage or civil union disturb a trust settlement and make an order for the benefit of the parties to the marriage or civil union or for the benefit of any children of the relationship.  Relationship property issues are also relevant where you have left assets to your children - if your child enters a relationship then those assets you have left to them may be available for claim by their future partners. If the assets are in trust or consist of a debt which is loaned by the trust, your child can enjoy the benefit of those assets without having to worry about relationship property claims.

Discretion over distribution to beneficiaries

When you write your will, your wishes are usually followed to the letter.  However, circumstances can change, and at your death there may be substantial gifts in your will to specific beneficiaries which may no longer be appropriate.  If you leave money and other assets to beneficiaries in your will, there is usually no control on how that money is spent, or how those assets are dealt with.  Family heirlooms could be sold, money wasted, assets diminished.  However if you transfer those assets to your trust, you can ensure those assets go only to the beneficiaries of your trust, with your trustees making the final decisions.  This helps to protect the content of your estate long after you've passed away.  Spendthrift beneficiaries won't necessarily be able to blow their inheritance on a shopping trip to Melbourne, unless your trustees all believe that it would be in their best interests to do so.  However, you need to note that if all beneficiaries are of age, they are together able to dissolve the trust and agree to the way in which the trust assets should be distributed.  That is another reason why it's important to choose your trustees carefully.

Asset-tested benefits

If you or a relative need long-stay residential or hospital care in the future, you may be eligible to apply for government subsidies for this care.  This is particularly common for people considering a move into a rest home or geriatric hospital.  The government will usually calculate whether or not you are entitled to the Residential Care Subsidy based on your personal assets and income.  If your assets are held in trust, they may not be included in the government's assets calculation, therefore increasing your eligibility to receive the subsidy.

Final beneficiary in your will

When you establish a family trust, it's a good idea to update your will at the same time.  Your trust will then usually be included as a beneficiary of your will, and this way you can leave most of what you still own to the trust instead of giving it to named family members directly.  You are still free, of course, to make specific gifts in your will to certain people, and provide for your beneficiaries however you see fit.  If you are likely to still owe the trust money at your death, you should consider whether your will should include a forgiveness of that debt.  As well as updating your will, your Lawlink lawyer will also work with you to draft a Memorandum of Wishes.  This is a document which accompanies your will and it simply gives your trustees guidance on how you'd like your assets to be distributed.  Your trustees aren't bound by this document, but they have an obligation to take your wishes into account.  Essentially, your family trust then becomes the engine which drives your will, and your Memorandum of Wishes.

Disadvantages of establishing a trust

Loss of ownership of your assets

When you transfer your assets to a trust, you no longer own these assets personally, and your trustees must administer them in terms of the trust.  Some people could consider this a disadvantage.  You can no longer treat the assets as though you personally own them - decisions about what happens to the assets will need to be made jointly by the trustees of your trust.  Usually, this is not a problem, and you can maintain a limited control by reserving to yourself the power to remove and appoint trustees, keeping in mind that as a matter of law, all trustees must act in accordance with the terms of the trust deed.

Costs

Costs can vary according to the complexity of the trust structure and the assets to be transferred to the trust.  You should contact your Lawlink lawyer to determine the cost of setting up your trust.  You will find that the cost is a very small percentage of the value of the protection you will gain from establishing a trust.

‘You can no longer treat the assets as though you personally own them - decisions about what happens to the assets will need to be made jointly by the trustees of your trust.'

What is gifting?

Gifting is the term given to the manner in which the settlor reduces the debt resulting from the transfer of assets to a trust. When you establish your trust, for the purpose of holding property, it operates as a separate legal entity.  However, it initially holds no assets of its own.  In order to transfer your house to the trust for example, you must sell it to the trust at fair market value.  Because the trust has no money to pay for the house, you as the homeowner lend the money to the trust to buy the house.  This is all recorded in legal documents, and no money ever changes hands.  The trust then owns the house, but also owes you the money for the house.  The debt that the trust owes you is your personal asset - you own that debt, you can recall it at any time, which means it is still something you own for the purpose of claims against you.  The object now is to get rid of that debt as quickly as possible.

New Zealand law provides that everybody can gift up to $27,000 every 12 months without paying gift duty - and that's how gifting operates.  Every 12 months, you ‘forgive' the trust a debt to the sum of $27,000 until the entire sum is paid off.  If you are a couple, each person gifts $27,000, so together you're gifting off $54,000 in one year.

For example, if you own a house worth $540,000, it will take you and your partner nine years to gift the entire house to the trust, if you make the first gift immediately the debt is established.  Your Lawlink lawyer will commence a ‘gifting programme', and this yearly gifting will be done around the same time each year.  Once the entire debt is forgiven, and if all transactions are completed and documented correctly, the trust then owns the house, and doesn't owe you a cent.  The asset will then be fully protected.

Each time you transfer an asset to the trust, it should be valued, and you then sell that asset to the trust for its market value.  Again, you lend the money to the trust to buy the asset, and this increases the debt the trust owes you.  This simply  means you'll be gifting off the debt owed by the trust for a few more years.

When transferring assets into trust, it's a good idea only to transfer those assets which are likely to increase in value.  If you transfer a car to the trust today that's worth $54,000, you've got to gift that off in two years.  However, it is likely that a car's value will decrease, which means you'll be gifting for longer than you need to.  Property, art, jewellery, investments, and maturing insurance policies are all examples of personal assets which may be suitable for transferring to a trust.

So, to trust or not to trust?  What's certain is that in the current economic environment, if you are in business, protection of your assets should be a priority.  We realise every person is different, and every family situation unique.  Family trusts can be adapted to suit your needs.

If you have any further questions, or would like to talk to someone about establishing a family trust, make an appointment with your local Lawlink lawyer today.  Alternatively, pick up a copy of our Lawlink Family Trusts booklet.  It contains helpful information that you'll need to know when deciding to establish your own family trust.

© AWS Legal
Email: dominique.fourie@awslegal.com
Website: www.awslegal.com

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