A “trust”, despite common misunderstanding or over-complication, is a contract. A trust is a legal relationship between three people: the settlor, trustee and beneficiary. When a trust is created, the settlor (who owns an asset of some type – called the “property”) transfers property to the trustee who holds legal title to the property. But the trustee holds the title not for his or her own benefit, but for the benefit of others – the beneficiaries. Depending on how the trust is structured will dictate when and how the assets are passed to the beneficiaries. There are approximately 40 different types of trust available at this time and they will all have different attributes that make them useful in certain circumstances. This aside, they all fall under two main categories:
1) Living Trusts
Technically referred to as an inter-vivos trust, this type of trust is set up while a person is still alive.
2) Testamentary Trust
This type of trust is set up in a persons will and takes form only after the person has died.
In the past trusts may have only been an option for the wealthy, owing to costly fees for establishment and maintenance. Now they are becoming increasingly popular among the affluent in their financial planning due to the continual reduction in entry and maintenance costs. So, what are the benefits of setting up a trust?
1) Use A Trust To Avoid Probate
Very often the first benefit to be cited in establishing a trust is avoidance of probate. Probate is the process of administering an estate (i.e the legal process for dividing and passing on assets of the recently deceased). This process can cost thousands and take months to complete. In certain situations the process can take years to resolve. Fortunately, not all of your assets are subject to probate. There are exemptions for jointly owned assets and assets with rights of survivorship, along with assets that have designated beneficiaries; life insurance policies, annuities and retirement accounts. Assets held in an irrevocable trust will not be subject to probate. Having your assets held in trust does not however mean that your estate will not be held liable for any outstanding debts that you leave behind. If such matters are pending at the time of your death, the trustees will not be able to distribute the trust property immediately and will have to wait until the conclusion of the outstanding debts. Trusts cannot remove your responsibility to settle outstanding debts. Assets held in trust will however be outside of the legal framework of probate, saving your family a considerable amount of money and time.
2) Use A Trust To Reduce Taxes On Asset Growth And Dividends
As the settlor of a trust renounces their personal ownership of their assets when assigning them to the trust, they are no longer subject to any tax liability derived from those assets. For example, if over the life of the trust an investment fund which was worth 100 at the time that it was transferred into trust is worth 200 some years later, had the asset still been owned outright by the settlor there would presumably be a tax liability on the gain of 100 (how much tax would be payable would depend on where the accountholder is a tax resident). As the asset is owned by the trust, and the trust does not have a legal personality (it is neither a corporation or an individual), any growth within the trust is not subject to taxation. The previous example is with reference to capital gains and capital gains tax. Assets which produce an income, or regular dividends, commonly create an income tax liability for the owner upon receiving those proceeds. In the case of a trust, these funds are received inside the trust and are not subject to taxation. They can then be re-invested. This is referred to as gross roll-up. As such, trusts can be referred to as tax deferred. The trust does not eliminate tax entirely, as when the beneficiaries receive proceeds from the trust, they will be subject to taxation on the monies received (again, based on tax residency). For the period that the assets are held in trust however, the assets are not subject to taxation.
3) Use A Trust To Protect Your Assets From Creditors
The reason that probate has the potential to be a long and drawn out process is that third parties have the opportunity to lay a claim against the estate of the deceased. For example, a disgruntled employee, distant family member, previous spouse, lover or claimant is able to legally lodge a claim to the assets of the estate of the deceased. Fending off such claims is a legal requirement that will invariably cost time and money. The people left to handle this dispute are usually the beneficiaries and other family members. Most people would like to avoid legal legal battles over money after having lost a loved one which often compounds the stress of the situation. Assets held in trust are protected from such claimants as they do not form part of the estate of the deceased. In certain circumstances the trustees are even able to decline requests from foreign governments to release assets whereby the local law of the trust takes precedence.
4) Use A Trust For Privacy
Depending on where the trust is based will dictate how the trust is legally registered. Many localities do not require a record of the trust to be lodged with the local government. In this sense, trusts, and their arrangements (i.e trust deed, settlor, trustee and beneficiary arrangements) are not of public record and remain private. People will require privacy for different reasons; complexity in their family relationships, previous marriages and extended family, business interests, distrust of their local government, jurisdictional risk, political exposure, kidnap risk and so on. There are trusts available to meet these objectives.
5) Use A Trust To Reduce Inheritance Tax
If you have assets when you die, before they can be distributed to your heirs and beneficiaries it is likely that your local government (again, this depends on where you live), will level inheritance tax on your estate. In developed countries inheritance tax can be up to 55% of the value of your assets. If your assets are held within a trust, seeing as the trust cannot die, there is no inheritance tax levied against those assets as a result of the settlor. Now, this does not eliminate tax entirely, as tax will be payable by the beneficiaries depending on how and where they receive proceeds; along with how much. This will likely be payable as income tax. Income tax however, is often much lower than inheritance tax, and as the disbursements can be controlled, there is considerable room for tax planning to minimise the tax liability of the beneficiaries.
6) Flexible Distribution To Beneficiaries
There is another angle to the inheritance scenario. Not only is the estate charged upon the death of the owner, but ordinarily these assets will then pass directly to beneficiaries. Now, in certain circumstances there may be negative tax consequences for the beneficiaries in receiving the proceeds at that particular time, to which there is no remedy and no alternative option. Trusts provide flexibility in this respect. If those assets were owned by the trust when the settlor died, one of the roles of the Trustees would be to determine the best method for disbursing the proceeds of the trust to the beneficiaries; including considerations of tax efficiency, longevity of the trust and any other factor where they can increase benefit and decrease cost/tax liability for the beneficiaries. Paying for a trust is essentially paying to have the option to be able to plan in the future; which will often enable the beneficiaries to make savings over and above the cost incurred.
7) Paying For Education With Trusts
Most people have heard of the term “trust fund”. It often comes up with reference to university and higher education. The trust can be structured to pay for the education of a beneficiary. This removes the personal tax liability of the individual beneficiary and potentially saves thousands in tax liability. It’s also arguably one of the best gifts that you could give to a child, and one of the best investments that you could possibly make. The dividends of a quality education are paid for a lifetime. Unsurprisingly, this is particularly popular among the affluent.
8) Efficient Management Of Assets
Depending on where the trust is established will determine which assets can be held in the trust. In most cases, all of the assets of the settlor can be held in trust where required. Similarly, if the trust is domiciled offshore then the trust will be able to purchase and participate in a much broader variety of investment opportunities than the settlor as a resident individual. Moreover, your portfolio and assets will be professionally guarded by a Trustee who has a fiduciary duty of care to ensure that any investment adviser or financial planner is acting in the best interest of the objectives of the trust and its beneficiaries. This centralisation of assets may reduce administration costs, will reduce unnecessary complexity where accounts where previously dispersed, and also offer increased investment access.
9) Eliminate Family Feuds About Money
Families will sometimes argue. Not everybody gets along all the time. This premise has never been more so than in the context of inheritance, where money is involved. Even with a last will and testament, the estate may be open to contestation or claimant risk during probate. These claims will be settled in court. Family relationships will be tested. Some damaged irreparably if the stakes are high enough. When using a trust the terms written in the trust deed are absolute and not open for discussion, nor challenge. The wishes of the settlor are honored by the trustees in their professional capacity as fiduciary. They have a legally mandated responsibility to do so. The thoughts and feelings of third parties are irrelevant. Resulting arguments or disagreements do not have any bearing on the pre-determined wishes of the settlor. Everybody gets what they are owed- no more, no less.
10) Benefit From Professional Advice
Trustees are licensed, regulated fiduciaries whose job it is to conduct the wishes of a settlor. It is a respected profession just like being an accountant or a lawyer and comes with the commensurate amount of responsibility. Where the trust has investable assets a financial advisor will often be involved to assist in the management of the assets, and to give prudent advice on the management of the monies so that they are able to meet the predetermined objectives of the settlor, as outlined in the deed of trust. As a result of this, the settlor has the peace of mind of knowing that all financial decisions have to go through layers of professional approval, and that the actions and decisions of the beneficiaries (who often may not have experience in money management, or may not be suitable to manage the entirety of the settlor’s estate) will not be to the detriment of the trust and its assets.
– Cornell Law Review: ASSET PROTECTION TRUSTS: TRUST LAW’S RACE TO THE BOTTOM? Stewart E. Sterkt
– North Carolina Bar Association: PROTECTING YOUR ASSETS: Wills, Trusts & Powers of Attorney
– STEP: What is a trust?