A number of people have asked me about the merits of Family Trusts, particularly in relation to property. This is a brief overview, designed to provide an introduction to Family Trusts prior to professional advice being sought. It might also prompt some of the questions you may wish to raise when talking to a professional.
If you are considering forming a family trust, you should write down the reasons you want to create the trust and discuss these with your accountant or financial adviser, as well as a solicitor or trustee service. You can then discuss the merits with your solicitor or trustee service and if you come to agreement, put the wheels in motion.
Decisions about the assets covered by the trust will be made by the trustees, which means you will need to be comfortable that you will no longer be able to treat the assets transferred to the trust as though they are your own.
You will also need to discuss the costs involved in creating and maintaining a trust with your solicitor, or trustee service. For example, Public Trust indicate that a straightforward trust including asset transfer costs approximately $2,500 to $3,000 to set up, but a more complex trust will cost more.1
Provisions will need to be made for the annual time and cost involved with running the trust, including the need for annual reviews, updates to beneficiaries, accounting and administrative requirements, and possibly gifting documents.
This information is provided as generalised advice, and professional guidance should be sought from your financial adviser or accountant and/or solicitor or trustee service prior to entering into a trust
Why consider a Family Trust
I’ll start with some of the reasons for establishing a family trust, which include:
- To protect assets from creditors, future claims, legal action and business risk; for example you may want to protect the family home should your business fail
- To put money aside for your family’s future, such as funding your children’s’ or grandchildren’s education costs
- To protect your assets in a second marriage/relationship, or against claims from a relationship breakdown (used along with a Relationship Property Agreement, or “pre-nup”)
- To assist with the administration of your estate, allowing family assets to pass to a another generation without exposing inheritances to relationship property claims, or other claims
- Succession planning, to ensure children and not their partners benefit from an inheritance
- To protect beneficiaries who are vulnerable, or who might have difficulty managing their own affairs, allowing the trust to provide funds to meet their financial needs as they arise
- Protection for your own retirement when you might be subject to subject to asset testing for, say, rest home charges. Although the way Work and Income New Zealand (WINZ) now assesses for residential care subsidies means trusts no longer easily defeat asset testing.
However, it is generally not effective to establish a trust with the principal objective of avoiding tax
What is a Trust
A Trust is legal structure to protect property and manage assets, such as your family home or investment properties. It principally includes three parties:
- A trustee or trustees – the person, or persons, nominated to manage the trust
- The beneficiary or beneficiaries – the person, or persons, who the trust in held and managed to the benefit of
- The settlor – the original owner of the assets to be passed into the trust (sometimes referred to as grantor), which can be gifted or sold depending on the reason for establishing the trust.
The operation of a trust involves a trustee or trustees holding and managing money, property, or others asset for the benefit of the specified beneficiary or beneficiaries.
The settlor will usually transfer the assets to the trustee once the trust has been formed. This occurs when the deed to record the terms of the trust has been signed and will be arranged by your solicitor or trustee service (for example Public Trust). There may be multiple settlors, trustees and beneficiaries and it is possible for one person to be a settlor, as well as being one of the trustees and one of the beneficiaries.
You will also need to ensure the family trust includes provisions to ensure it is robust and flexible. Again, this will need to be discussed with your solicitor/trustee service and should include the power to adjust the Deed, power of resettlement, class of beneficiaries, portability provisions and power to add additional beneficiaries.
Unlike companies, family trusts are not publicly registered so therefore can be kept confidential.
Independent Trustees
It is important to ensure trusts are well managed as poor trusteeship and management can lead to trusts being overturned. There’s no legal requirement for a trust to have an independent trustee. However, an independent trustee can help demonstrate that the trust is genuine, helping to protect it from attack from other parties, such as creditors. An independent trustee can also help ensure the trust’s administration is properly carried out and decisions recorded. The trustee should be aware of their obligations, for example the requirement for annual reviews and updates to beneficiaries.
If the trust does have independent trustees, it is important to ensure that they are not exposed to financial risk from any debt obligations that may arise, by ensuring the trust deeds include an indemnity that the trustee is indemnified by the trust’s assets. This means that if the trustee is called upon to pay the trust’s debts, the trustee can use the trust’s assets to pay those debts.
Of course, the trust’s assets may fall short of its obligations in bad times, so the trust should ensure that every significant financial obligation contains a limitation of liability. For example, if the trust enters into a loan with a bank, the loan document should include a clause saying that the trustees’ liability to the bank is limited to the value of the trust’s assets. These are raised as considerations to discuss with your solicitor when forming and performing the duties of a trust.
Bank accounts
If the trust is likely to receive income and make transactions a trust bank account will need to be established. Assets such as a house, rental properties, business and investment portfolio, can be transferred into the trust. A property could be put in trust, without the need for annual accounts, but if the trust is receiving income then accounts will need to be prepared. Wills need to be linked into the family trust and written in such a way that in the event of death, surviving assets go into the family trust. Ownership of insurance policies should also sit with the family trust.
Taxation
New Zealand’s Trust law means that it is generally not effective to establish a trust with the principal objective of avoiding tax. If there is a tax saving, it must be seen as an merely an incidental benefit. Indeed, the courts have been very careful to examine the reasons behind the establishment of trusts for this very reason.
Trusts are taxed at the maximum individual rate (currently 33%), which is higher than the company rate (currently 28%), pointing to an advantage in considering a company structure. It may be that you can make tax savings if the trustees have flexibility to decide which beneficiaries should receive income each year, so that income is distributed to beneficiaries at a lower personal rate, but this would require careful advice from a tax expert. (Note that the “minor beneficiary rule” ended the ability of trustees to direct income to beneficiaries aged 16 and under in order to access lower tax rates).
Protection from residential care testing
Family trusts have been put forward as a vehicle for protecting the family’s assets during retirement should you require rest home care, but find your personal assets exceed the threshold to receive the WINZ residential care subsidy (currently around $230,495). However, this would need to be discussed with your solicitor, to ensure the trust is not scrutinised by WINZ. Indeed, the way Work and Income New Zealand (WINZ) now assesses for residential care subsidies means that asset testing is rarely defeated by the creation of a trust.
The rules for asset testing are complex, so should be discussed with your solicitor. Presently, you may gift only $27,000 a year (reducing to $6,500 a year for the five years immediately prior to receiving a subsidy). If only one spouse or partner is in care, your combined gifting as a couple must be below those limits. This means that in some cases, people who are about to go into care may find they do not qualify for the subsidy because of the amounts they put in their trust in the past.
The gifting amount can be averaged during the five year period during which the amount is reduced, if too much has been given in one year, as long as the average is kept within the prescribed limits. Gifting prior to that five year period cannot be averaged out. Again, this would need to be discussed with a solicitor.
Notes:
1. https://www.publictrust.co.nz/__data/assets/pdf_file/0018/107811/PTEL14-Family-Trusts-Pricing-Table-2018-08.pdf
Further Reading:
The New Zealand Law Society provides more information on trusts:
https://www.lawsociety.org.nz/news-and- communications/guides-to-the-law/the-family-trust
Lawlink provide information on the advantages and disadvantages of trusts:
https://www.lawlink.co.nz/article/family-trusts-advantages-disadvantages-trust/
NZLaw (www.nzlaw.co.nz) have a number of related articles, including Do I still need a trust?
https://www.nzlaw.co.nz/news/do-i-still-need-a-trust/