Family Trusts - Protecting Your Assets from Predators
Refer also to:
- The Property (Relationships) Amendment Act 2001
- Gift Duty Rates
- Why form an LAQC
- Asset Testing - Rest Homes
- Role of Trustees
Trusts originated in feudal England when the king awarded land to knights returning from battle. The knights would develop their estates, only to face the danger of their lay-about sons squandering their inheritances. To prevent this, the family patriarchs would bequeath their lands to their fellow knights to hold in trust for the benefit of the family. Little has changed in the last 800 years.
Officially a trust is a legal obligation created by a person (the Settlor) who gives assets into the control of another person (the Trustee) for the benefit of a third person (the Beneficiary).
The person setting up the Trust is called the Settlor. This is either the person with the assets that are being gifted to the Trust or it is a professional adviser or close family friend. The Settlor can be the two people who own the assets or just one individual. The Settlor can have a range of functions and these will be dictated by the Trust Deed. However, in most modern Trusts, the Settlor is simply the person who sets up the Trust and then has no other important powers.
In the event that Mirror Trusts are established, then the owner of the assets will always be the Settlor of his or her own Trust.
The Trustees are effectively the policemen or referees of the Trust. They are responsible for ensuring that the rules of the Trust (the Trust Deed) are correctly followed. The Trustees are usually those people who own the assets that have been transferred into the Trust. By becoming a Trustee, you effectively control the administration of the Trust yourself and hence you have a degree of control and guidance over your original assets. Most Trusts have two or more Trustees.
There is constant debate within the legal profession about the number of Trustees a trust should have. From a purely legal perspective, you could get away with having just one Trustee. If you establish a simple discretionary Trust, we believe it is acceptable for our clients to have two Trustees administer the Trust. They would usually be the two individuals (partners) whose assets had been transferred into the Trust.
The beneficiaries are the individuals who benefit from the Trust. They will normally do so entirely at the Trustees' discretion. No discretionary beneficiary can force the Trustees to make any payment to them. Most modern Trusts are created in order to provide maximum flexibility to cater for changing circumstances. It is for this reason that the Trust Deed will list a multitude of beneficiaries who may be current living individuals, or individuals still to be born. The Trust Deed. How does the Trust work.
The Trust Deed.The Trust Deed is the set of rules by which the Trust is operated. The Trust Deed should reflect the wishes of those establishing the Trust and it should be worded so that it is easy to understand. The Trust Deed needs to be carefully drafted so that it will provide maximum flexibility and cater for any eventualities which may occur.
How does the Trust work.
You establish a Family Trust and then open a Family Trust bank account. You will then decide what assets you want to initially put into the Trust. For example, you may wish to place your house, rental properties (careful please refer to Forming a LAQC Company), business and investment portfolio immediately into the Trust. This may hypothetically amount to say $1m. A "Deed of Acknowledgment of Debt" needs to be prepared which states which assets (and their value) that are being transferred to the Trust. These assets would then be registered in the name of the Trust and you would effectively have an interest free loan from yourselves back to the Trust. Each individual is allowed to gift $27,000 per annum without incurring gifting duty. This means that jointly and separately, a couple may gift $54,000 each year. This is done through an annual gifting statement to the IRD and acknowledged through a "Deed of Partial Forgiveness of Debt" . At the end of every 12 months, you must complete a gift statement stating that you have forgiven a further $27,000 (each) of the outstanding debt from the Trust to yourself. This means that in ten years time you will have gifted $270,000 of your assets into the Trust. This money that has already been gifted into the Trust is effectively protected from 'predators and creditors' Any money or assets which have not been gifted into the trust and had the debt forgiven will remain at risk.
The advantage of selling the assets to the Trust immediately is that any capital gain and income which is derived from those assets is then captured by the Trust and not by yourself. For example, $1m in assets which may appreciate at say 5% per annum, would effectively be increasing at the same rate that you are trying to gift them to the Trust. This means that you would never be able to move ahead and gift the assets to the Trust without paying gift duty.
At any point in time you, as Trustees for the Family Trust, can distribute money to the beneficiaries. You may be a beneficiary and a Trustee.
In recent years, the appointment of a Protector has become fashionable. This Protector is often an independent person who is not a Settlor or Trustee of the Trust. It should ideally be someone who is totally independent, has no vested interest in the Trust and no 'axe to grind '. The Protector should be someone who can be trusted to ensure that your wishes (as set out in your Memorandum of Wishes) are followed. The primary functions of the Protector are:
- "To hire and fire Trustees (other than yourselves unless you lose your mental faculties);
- To ensure that your wishes (as set out in your Memorandum of Wishes) are followed by the new Trustees after your death;
- To resolve disputes between Trustees;
- To ensure that your Trust is not hijacked by independent Trustees should changes in the law make it necessary to appoint them;
- To appoint new Trustees which usually will be necessary only after your death, but may become necessary as a result of changes in government policy or legislation."
Memorandum of Wishes.
A Memorandum of Wishes is not a legally recognised document. It is simply a document which records your wishes for the distribution of the Trust's income and assets. It will also cover who you would like to see appointed as a new Trustee if you became disabled or died. Your Memorandum of Wishes should be regularly updated as your wishes and desires change. You do not need to have a lawyer assist you with making changes to your Memorandum of Wishes. It does not have to be legally precise. All it needs to do is be clear and easy to understand. Your Memorandum of Wishes is designed to give guidance to the surviving Trustees of your Trust.
WHY HAVE A FAMILY TRUST?The reasons for establishing a Family Trust are many and varied. It is best to look at establishing a Family Trust as early as possible in your money making career. This helps to add a degree of legitimacy to the Trust and you can probably then justify a number of reasons as to why that Trust has been established.
Below is a list and some accompanying comments on the most common reasons for Family Trusts being established. These are:
Minimise costs and red tape when distributing your estate after death.
If you have a Family Trust in place and you structure yourself so that your Will transfers all remaining assets to the Trust as opposed to the spouse then it helps to reduce the red tape and costs associated with an executor administering your estate. Hopefully when you die, the Trust will have been established for a sufficiently long time frame that the bulk of the assets has already been gifted to the Trust. If this has occurred, probate is simplified and any remaining assets can be more expeditiously transferred into the Trust.
Flexibility in case of law changes and changes to your own circumstances.
There is nothing surer than death and taxes and equally, there is nothing surer than the fact that your own circumstances and legislation will change during your life. No one can accurately predict what future changes in legislation will occur and what impact they will have on your investments, your tax structure, and what may happen to your assets in the event of your death. Therefore, if you have a well constructed Family Trust, which is robust and capable of withstanding challenge, and if it has a good degree of flexibility, then you are in a strong position whereby you can be relatively 'bullet proof' in the event that changes are made to taxation law and to your own personal circumstances. Flexibility is the key with modern day Trusts and you must ensure that any Trust that you are a part of contains that flexibility.
Reduce family tax liability.
Trusts should not be established purely to minimise tax. However, in many instances, Trusts are a way of legitimately minimising your tax liability.
Protect your assets if you remarry or if the surviving spouse remarries.
We have seen numerous examples with our clients whereby one partner dies and all of the assets are left to the surviving spouse. That spouse then remarries and after say three years, he or she separates from their new partner. That new partner is then legitimately entitled to half of the matrimonial property and they subsequently separate with the new partner taking away a fistful of dollars. Such an action can lead to family discontent and resentment and particularly children of the deceased party often feel as though the survivor has mismanaged their future inheritance as they see it disappear with the partner who remarried. If you establish a Family Trust, you can certainly avoid this issue from occurring. You can clearly indicate in your Will that when you die, all of your assets are to be placed into a Family Trust. That Family Trust will have rules in the form of a Trust Deed and or a Memorandum of Wishes which would outline how the Trusts assets are to be administered for the benefit of the family and the surviving spouse. If the surviving spouse subsequently remarries, then the new partner is not eligible for the assets or the income of the Family Trust. It is then much easier for the surviving spouse to say to their future partner that their assets are tied up in a Family Trust rather than requesting a prenuptial agreement be prepared.
Protection against creditors.
Being in business today is far more risky than what it used to be in the past. 75% of new businesses fail within the first four years. As a business owner, you need to protect yourself in the event that if your business fails and your creditors are seeking damages from you your assets will be protected. Often, it is through no fault of your own that your business fails. Therefore, all business owners should be considering the establishment of a Family Trust and that Family Trust should own the shares in their business. It then means that if the business happens to fail, then you as the director may be personally sued but if you have little or no assets, then the pain is not too great. Hopefully, you would have established the Family Trust sufficiently far in advance that you would have gifted all of your assets into the Trust and this would protect your assets in the event that you were sued. It is for this reason that we encourage most clients to establish a Family Trust sooner rather than later.
Minimise the chance of the court altering your Will.
An increasing number of Wills are now being contested by beneficiaries of that Will. This is particularly the case if there are split marriages or the assets were distributed inequitably amongst the survivors. One way to ensure that your wishes are actioned on your death is to have all of your assets in the Family Trust. It then means that the Family Trust continues on relatively unaltered once you have died. This will hopefully help to reduce the likelihood of your Will being contested by others. In many instances, Wills have been contested. In court, the judge will listen to all sides of the argument and will then pass a judgment which could result in the deceased 's wishes actually being overturned in order to provide a greater level of equality to all claimants. This may be great for those who are going to receive an inheritance but it may be totally contrary to the wishes of the benefactor.
Increased chance of obtaining a rest home subsidy.
The granting or non-granting of a rest home subsidy is an emotive issue for the elderly. Too many retirees fail to establish a Family Trust and then one or both of them ultimately end up in a rest home. Rest home fees can often amount to $1000 per week. The government will only start to implement a subsidy in the form of a rest home subsidy once your assets have been significantly dissipated. Before you can get government help, your assets must be reduced to the following levels (effective 1st July 2005):
- If you are single or widowed you will be eligible for financial help if you have assets of less than $150,000.
- If you are a married couple, both of you are in long term residential care, then you will be eligible for financial help if your joint assets are less than $150,000.
- If you are married, but only one of you is in long term residential care, then you will be eligible for financial help if your joint assets (excludes house and car) are less than $55,000.
- Your house and your car are not treated as assets for the purposes of these tests if (and only if) you have a spouse or dependent child still living at home. If this is not the case, then the house and car are otherwise included as assets.
- These limits will increase by $10,000 each year.
The eligibility criteria from New Zealand Income Support Services for obtaining the rest home subsidy is very strict. They have the ability to go back through your affairs to see what you have done with your assets. If you set up a Family Trust today and then applied tomorrow for the rest home subsidy then the likelihood of you receiving it is very low. Therefore, you need to establish the Family Trust well in advance of you going into a rest home and then ensure that you gift as much of your asset base to the Family Trust as soon as you can so that you are well within the five year time frame that the assessors (from Income Support Services) are likely to go back to, to see what you have done with your asset base. Once again, Income Support Services will be looking at the intent behind the establishment of a Family Trust, how long it was since you established that Trust and the degree of legitimacy associated with that Trust establishment. We have seen numerous instances whereby people are getting full access to the rest home subsidy and yet have literally a million dollars sitting in a Family Trust. This enables them to benefit from their labours over the years through paying taxes and now receive a subsidy while preserving their assets for their spouse who is not in the rest home for future generations.
Minimise estate duty if reintroduced.
Estate duty was a tax which applied to assets in excess of $400,000. It was applied once a spouse had died. Unfortunately, estate duty has not been fully abolished. Instead, it was reduced to a zero rating. There is no guarantee that estate duty will remain zero rated. Various political parties have announced that they would like to either reintroduce estate duty or introduce some form of inheritance tax. Around the world, inheritance tax is a common revenue generator and the likelihood of it being reintroduced in New Zealand is reasonably high. We may all be alive for a long time to come and hence no one can predict with any degree of certainty which party will be in government when we die and whether there will be estate duty or not. By establishing a Family Trust and transferring your assets from your own name into the Trust, then it reduces the necessity to gift assets just prior to death and this will hopefully eliminate or reduce any potential estate duty liability in the event that it is reintroduced.
Surtax was charged for superannuitants at the rate of 25% in the dollar above the minimum threshold. If all of your income producing assets were in a Family Trust, then the income was attributable to the Trust and not to you, the individual. Therefore, you could literally have a million dollars sitting in Family Trusts earning income and it would not be deemed to be your own income and hence no surtax would be paid. With changing governments there is no guarantee that Surtax, or some similar type of tax, will not be reintroduced between now and when we eventually die.
Making your existing home a tax effective rental property.
Ross Holmes makes the following point:
"If you borrow to purchase a new family home, you will get no deduction for income tax purposes for the interest paid on the new loan. If your Trust purchases your existing home from you as a rental property and borrows (to enable it to pay all the part of the purchase price to you) your Trust will get a deduction for income tax purposes for the interest paid on the new loan. The Trust can in turn pay the loan to you (as payment/part payment for your existing home). That payment can then be used by you as all or part of the purchase price of the new family home."
We do not recommend the practice by some accountants of shifting a home into a family trust or LAQC company and the owners paying a rental into the entity thereby turning their home into a rental property where their tenant is themselves. The IRD use the Associated Persons Rule to see through this transaction as a sham.
Keep your business running after death.
This will obviously vary depending upon the size and profitability of your business and what role you have played in your business just prior to your death. Many small to medium sized businesses are totally dependent upon the owner/share holder for its continued future. In the event that the owner dies, then the business needs to be sold and often for a significantly reduced price. If you structure things correctly so that the Family Trust owns all of the shares in the business then in the event that you die, the Family Trust can appoint a new director be it a Trustee or some outsider to continue running that company. The Family Trust can then decide whether it runs the company long term or organises an orderly sale of the business.
Prevent spendthrift children blowing your hard earned capital.
You can mention in a Memorandum of Wishes or in the Trust Deed how you want your assets to be administered after you have died. This can prevent spendthrift children from getting access to all of the money too early in life and then blowing it. The Trustees are often instructed to only provide a limited amount of income and then to possibly increase that level of income as and when the Trustees feel that those children are competent and capable of handling that income.
Prevent children's partners benefiting from your capital.
This is a common area of concern for owners of assets. There is an increasing number of marriages ending in divorce and the partners of your children could walk away with half of the matrimonial property. You can prevent this by having your children 's assets sit in the Family Trust and in the event that they split, then it is not the original capital of your children which is being lost but only that which your child and his or her partner have actually accumulated in the time that they have been together.
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|value of Gift||Duty Payable|
|0 to $27,000||NIL|
|$27,001 to $36,000||5% of value over $27,000|
|$36,001 to $54,000||$450 plus 10% of value over $36,000|
|$54,001 to $72,000||$2,250 plus 20% of value over $54,000|
|Over $72,000||$5,850 plus 25% of value over $72,000|