The A - Z of Personal and Family Trusts

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Wednesday, June 14th 2000, 4:54PM

What are the advantages of a trust?

• A properly established trust cannot be contested in the same way as a bequest under a will. A trust gives the settlor greater certainty that his/her wishes will be implemented
• Difficulties with the combining and distribution of matrimonial property can be avoided through the use of trusts
• Trusts can provide a certain level of protection from creditors
• Depending on how the trust's income is distributed there maybe some tax savings available
• A trust may offer a protection should estate duty be reactivated or if capital gains tax is more widely implemented
• Certain trusts can be set up for a specific purpose (e.g. education) and must be used for that purpose
• A trust may exempt assets from current and future asset testing.

What are the reasons for setting up a trust?

Every person considering a trust has a different purpose and the reasons are vast, but here are some of the more common reasons:

Protection of families
Ensuring there is proper provision for families in future years.

Protection of, or providing for, individuals
Here an amount is set aside and might either be held until that individual such as a grandchild attains a certain age, marries or until a certain event occurs, such as when funds are needed to buy a house.

Protection of a person with a disability
This is a very popular reason to establish a trust. Funds can be set aside for that person in the knowledge that the trust will continue on beyond the settlor's lifetime. Such a trust might also have added to it at a later date an inheritance from the settlor's estate or possibly the proceeds of a life insurance policy on the settlor's life.

Providing for education
The purpose here is to set aside funds over a period to provide for future educational needs. Education trusts are very popular, particularly with the rising cost of all forms of education and the likelihood of having to have very substantial sums for tertiary education.

For health savings
This is a form of health insurance where you basically insure yourself. By setting aside funds regularly into a trust, money can be made available to cover health costs. This may avoid a situation where a person's health insurance premiums are in excess of the amounts claimed.

Protection of assets against creditors or other claims
It is now common for persons who are either in business, might have given guarantees or be acting as Directors of companies or trustees and thereby potentially incurring legal liabilities, to set aside their assets in trust. If claims arise against them, their personal assets will be protected for their later benefit or for the benefit of their families.

Protection of assets for future generations
By using a trust, a person can set aside assets for future generations and in effect implement the provisions of his/her will during their lifetime. It has become popular for people to put assets such as house properties in trust for their children or future generations.

Matrimonial circumstances
Trusts in conjunction with a Matrimonial Property Agreement can be used to make a marriage settlement when persons are about to become married and do not wish their assets to be mixed together, or in cases where persons are either married or in a relationship and wish to protect assets for their own children as distinct from their partner's children. A great deal of subsequent difficulties can be avoided through the use of trusts in these circumstances.

For charitable purposes
Setting aside funds for charitable purposes has long been a popular reason to establish a trust. With increasing stories of major charities experiencing difficulties in raising funds it is therefore an advantage to establish a Charitable trust, thereby ensuring that the capital of the trust will be protected for all time and not caught up with the charities' financial difficulties. The bequest will continue to provide benefits for the charitable purpose over a long period. It is also possible in this way for the ongoing recognition of the benefactor to be secured.

Taxation planning
Over the past few decades trusts have been used for reducing taxation liabilities. The general object here is to take income out of the hands of the person who is on a higher tax rate and either capitalise the income so that the tax is paid by the trust or pass it on to other beneficiaries who are on lower tax rates. There can be significant tax savings.

Who are the parties associated with a trust?

Settlor(s)

This is the person or persons who originally establishes the trust.

trustee(s)

This is the person or entity to whom the trust property is given. The trustee(s) must hold the trust property as directed under the terms of the trust and also generally must observe the duties and obligations placed on trustees by law. Where more than one trustee is appointed, the trustees are known as Co-trustees. It is also possible to have an Advisory trustee. That is a person who can be involved in an advisory capacity, but who does not have the same legal responsibilities as other trustees.

Beneficiaries

These are the person(s) for whose benefit the trust is established. In a straightforward trust, there might be assets held for a child or grandchild. In a Family trust there might be a group of beneficiaries ranging through grandparents, parents, children, grandchildren and any other persons specifically named or provided for. It is not essential that fixed shares be specified at the outset. Where these are not fixed the trust is sometimes called discretionary.

What are the duties of the trustee?

There are many legal duties placed on a trustee. Some of them are:

Making sure you know the Terms of the trust

While this will appear obvious, it can be a problem for inexperienced persons who must not only have read and fully understood the Deed, but have an understanding of the impact of past law and legal cases that could affect the interpretation of the trust.

Taking control of and protecting the assets

It is fundamental that the trustee must fulfil this obligation. It will include obtaining documents of title, insuring the assets and making sure they are physically protected.

Meeting legal obligations

The trustee will have to meet any legal obligations imposed by the trust Deed or by law. For instance, a tax return must be filed, proper records must be kept and there will usually be a requirement for annual accounts.

Investing the assets

Unless otherwise specifically instructed by the trust Deed, a trustee must take into consideration when formulating an investment policy the amendment to the trustee Act 1956 made in 1988, which places a greater responsibility on trustees. There is a list of factors in the trustee Act 1956 that a trustee must take account of in setting investment policy. The law change was introduced to help protect beneficiaries from trustees who poorly invested assets and failed to follow proper investment practices. There are now examples of cases where trustees have been taken to court for not acting in a prudent manner in relation to investment practices.

To act impartially

This simply means that the trustee must take account of the interests of all beneficiaries and act without favour. This can sometimes be a problem where a family member or friend is the trustee.

Why choose Trustees Executors to be a Trustee?

Trustees Executors can act as sole Trustee or as a co-Trustee, and this is a beneficial role to take advantage of for four main reasons:

• Impartiality. When a difficult decision arises, impartiality can be very beneficial. Trustees Executors will stand in the middle and listen to all points of view, encouraging a reasoned, fair solution. If a decision must be made we will do so impartially, having taken account of all factors.
• Permanence. Trusts with private individuals as Trustees may experience problems when Trustees are changed either through death or resignation. This can create difficulties particularly regarding family circumstances and background knowledge. As the first Trustee company in New Zealand, Trustees Executors has been operating for 123 years, and has the stability and resources to manage Trusts through several generations.
• Security. We understand the importance of your assets to you and the faith you put into the Trustee who is holding those. If you appoint a private Trustee, what happens if something goes wrong with their personal circumstances? Could the Trust assets get mixed up and lost? Will the private Trustee always be reliable? Trustees Executors is a professional Trustee company and part of a larger financial services group. It maintains professional indemnity insurance cover and keeps all client assets separate from its own. They do this by using individual Trust accounts and by making investments in the Trust's name.
• Specialist. Trust management can be a very complicated area of the law to navigate. Trustees Executors is a specialist Trustee company with a full knowledge of the law, and the experience and specialist skill of over 123 years of practice. Very few individual Trustees can claim such specialist status.

Placing Assets in the trust

When placing assets in a trust, it is important to take account of the Estate and Gift Duties Act. It limits the amount that can be gifted by any person during any one year before gift duty must be paid.

At the time of writing, it is possible for any one person to gift an amount of $27,000 during any 12-month period. In other words, all gifts made during any 12-month period will be added together and if they exceed $27,000, gift duty must be paid.

It should be noted that:

• The gift can be either money or property, in which case the value of the property will be the market value at the time the gift is made.
• Where over $12,000 is gifted, a gift statement must be declared and filed with the Inland Revenue Department.
• Generally, small gifts such as Christmas and birthday presents will not be counted.
• Gift duty does not apply to gifts made to charitable trusts.
• There should be proper documents in place to evidence that a gift has been made.

Gifting Assets to the trust

This is the most common means of transferring assets into a trust. There are several different forms a gift could take. For instance:

• A cash amount or an asset could simply be gifted to the trust and in effect transferred to it or;
• The trust could purchase the asset leaving a loan owing back to the seller. That loan can then be gifted away or in effect forgiven by the seller over time, depending on the value.

Remember that, if an asset is to be gifted it must be valued on a market basis, otherwise the short paid value may be deemed to be added to the gift.

A newly established trust will often not have any assets other than those transferred into it when it was set up. That could be a very nominal amount. If a larger asset such as a property or an investment is later to be placed in the trust, then an outright gift of the asset could create a gift duty liability.

The most common method in these circumstances is for the trust to purchase the asset from the person transferring it. For example, a house property is sold to the trust at its current market value of $140,000:

• The trust acknowledges that it owes the seller the sum of $140,000, which is on agreed terms and perhaps repayable on demand. Depending on the circumstances, interest may or may not be charged.
• The trust now owns the property worth $140,000, but has a liability in the form of a debt owing back to the seller.
• That debt can be reduced over time by a gifting process. The gift would simply be by way of a deed of forgiveness being completed by the seller whereby he/she acknowledges that the debt is forgiven by a certain amount. Usually, this would be the maximum of $27,000 per annum.
• Where the property was owned jointly and placed in the trust by the joint owners, then the loan could be acknowledged as owing one half to each of them. In this way they could each gift $27,000, making a total of $54,000 each year.

Practical example of a Family trust

Giving a practical example best shows the operation of a Family trust.

Jim and Rosemary Brown have been successful in business and had also inherited funds from their parents. Both in their mid 40s, they had three children, Bruce, Peter and Mary who were aged 17,15 and 13.

They decided to set up a Family trust with an external professional trustee for the benefit of the family, both current and future. The trust Deed also allowed the trustee some discretion to make payments to spouses of the children and grandchildren and to provide for Jim's mother who now lives in an ownership flat.

They transferred assets into the trust and in doing so, selected growth assets including some shares and other investments which they expected to grow over a period of time.

While the children were still at secondary school, there were few drawings on the trust and each year Jim and Rosemary Brown allowed the income to become re-invested so the capital of the trust would build up faster. They also continued their regular programme of making gifts to the trust, thus allowing it to grow in size.

When they set it up, they stipulated that it could run for the maximum allowable time of 80 years, but with the proviso that the trustee could bring forward the date of final distribution if that was thought desirable.

As the children passed through their secondary education, two decided to go on to university and it was possible to assist with their fees and other expenses from the trust. Income was applied to them and as the children had little other income, that part of the income was taxed at the children's' tax rate. If Jim and Rosemary had paid the costs out of their own pockets, the income to meet these costs would have been taxed at their higher personal tax rate. The other son, Peter, decided he would become a computer technician and the trust provided some funds to allow the purchase of equipment.

Unfortunately for them their business suffered some financial difficulties when they were in their 50s and they chose to give it up. They managed to sell up the remaining assets but ended up with a far lower value than they had hoped.

Most importantly for them, the assets of the trust were not affected. If for instance they had gone bankrupt, the trust would have continued on completely separate as a nest egg for the family.

Although the trust was reasonable in size, Jim decided that as he was no longer going to be able to contribute surplus funds to continue building it up, he would take up a life insurance policy which he duly did providing that the policy would pay proceeds to the trust in the event of his death.

Through the years, the trust was able to provide some assistance to Jim's mother who in time became hospitalised and needed some specialist care. These payments were entirely at the choice and discretion of Jim and Rosemary Brown and the trustee.

With Jim and Rosemary now in their mid 60s, they consider whether the trust should be wound up. Their children are now all well established. They have grandchildren (five in total) and have no direct financial need for the capital themselves. Jim and Rosemary decide to allow the trust to continue on and the trust now concentrates primarily on the educational and other needs of the grandchildren.

Their son, Bruce, himself falls on a period of ill health and Jim and Rosemary offer to have the two children live with them. The children stay for six months and during that time Jim and Rosemary draw funds from the trust to help pay for clothing, food and other essentials. As with the other payments made to the children and grandchildren, there is a tax benefit for them in doing this. The money is provided for the grandchildren who are on the lowest tax rates.

Well into the future, the trust continues to operate. Jim and Rosemary have passed away and the trustees now consider the future of the trust. In time the trustees decide to wind it up, distributing the capital one third to each of Jim and Rosemary's children. Two of the families in turn decide to use the capital to establish new Family trusts and the process starts again.

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