Taken on trust
Many people, when they hear the word “trust” in the context of financial planning, tend to think of a vague and mysterious concept which has no practical bearing on their lives. However, almost every one of us has been, or at some time will be, involved with some type of trust.
Some practical examples of trusts in “everyday” life are, for example, the par- ents of young children who provide in their Will for the creation of a trust to look after their offspring’s future inheritance in the event of their simultaneous deaths. Another example of a trust structure in common use is that of the “unit trust” (officially called a “collective investment”): the shares held by the investors in a so-called “unit trust” are in law held in a special type of trust and every unit trust investor is effectively a beneficiary of a trust. Similarly, a pension fund is simply a statutory form of a trust.
Despite often appearing at first glance to be a complex structure, the trust is in fact one of the most powerful tools available to a person when planning an estate - but what exactly is a trust and how does it work?
Simply put, a trust is a structure in which a person transfers assets to other parties, who then administer and control the as- sets on behalf of one or more beneficiaries, in accordance with the trust instrument (which could be a trust deed or a Will).
The person who initiates the trust agreement is known as the “founder” (also some- times called “the settler” or “the donor”). The trustees are the people (and/or an institution) nominated by the founder to be the legal owners of the assets in the trust and are responsible for the administration of the trust and its assets.
The beneficiaries are the people who bene- fit from the assets in the trust by earning income or receiving the capital of the trust at some point. A trust beneficiary can also be a trustee, and the founder can also be both a beneficiary and a trustee.
The types of trusts one comes across can be described in various ways, depending on (a) how they are formed, or (b) what rights the beneficiaries have, or (c) for what purpose they are formed. These various tags which are commonly applied to trusts can lead to confusion. Simplistically, however, every trust can be categorised according to these criteria:
Manner of formation - trusts can be formed during the founder’s lifetime (known as an “inter vivos trust” – in Latin “between the living”) or after his or her death based on instructions contained in a Will (known as a “will trust” or “testamentary trust”)
Rights of beneficiaries - trusts confer different rights on the beneficiaries concerning the distribution of income and capital. A "vesting trust" is one where the trust instrument stipulates precisely when and how income and capital is to be distributed to beneficiaries, whereas a "discretionary trust" allows the trustees to decide when and how such distributions are to be made
Purpose of trust - trusts are also often described by the purpose for which they are formed, for example, “asset protection trust”, “trading trust” or “business trust”
Thus, for example, a traditional “family trust” is usually an inter vivos trust set up during the founder’s lifetime for the purpose of holding and protecting his family’s wealth, with the trustees being given a discretion to distribute the income and capital between the various family members as they see fit, during the founder’s lifetime or after his death (such a trust would thus be described as an inter vivos discretionary family trust).
A trust to die for - The Testamentary trust
In terms of estate planning, one of the most common forms of trusts is the testamentary trust. As this type of trust is created in the founder’s Will, it does not come into existence until the founder’s death. A testamentary trust is most commonly used to administer and protect assets inherited by minor children or by anyone else not skilled at looking after money. Holding assets in a testamentary trust for minors until they reach their majority is the best way to protect the assets from being used for purposes other than their benefit and wellbeing. Furthermore, unless a testamentary trust of this nature is created in a Will, then there is a likelihood that a mi- nor heir’s inheritance will have to be paid into the State administered Guardian’s Fund for the duration of the minor’s minority. This would require the child’s remaining guardian to approach the Fund whenever the child is in need, and fairly rigid and inflexible rules apply.
A living thing – The inter vivos Trust
An inter vivos trust is set up during the founder’s lifetime. It is usually created by a trust deed – an agreement between the founder and the trustees, who are appoint- ed in the trust deed. The trustees, who manage the trust fund for the benefit of the beneficiaries, usually have extensive discretionary powers.
This type of trust is ideal for accumulating and holding growth assets such as shares, unit trusts and fixed property in order to keep the growth on these assets out of the founder’s estate. The increase in the value of the assets after they are placed in the trust occurs in the trust. This means that, at the founder’s death, no estate duty is levied on the assets in the trust and the beneficiaries get the full benefit of their inheritance. While the founder is alive, he usually remains a potential beneficiary of the trust and thus can still enjoy the bene- fits of the assets in the trust. This trust therefore offers an excellent way to limit estate duty. However, it is important to transfer the assets to the trust well in advance in order for most of the growth in value of the assets to take place in the trust, rather than the founder’s personal estate.
Other potential benefits obtained by placing one’s assets and investments in an inter vivos trust include:
Trust assets are excluded from the executorship process which occurs on one’s death – these assets are thus not frozen in a deceased estate situation and are immediately available to surviving trust beneficiaries and executor’s fees are not levied on the value of the trust assets
The trustees appointed by the founder retain complete control throughout the whole process
Due to the continuity of assets and property management with a trust, the founder’s heirs enjoy uninterrupted income
The founder’s spouse and heirs avoid much of the emotional trauma, aggravation and frustration often associated with a normal Will
If the founder becomes incapacitated, the trustees continue to handle the trust assets, avoiding the need to apply to the court for the appointment of a curator
A trust protects the founder’s children, and ensures his wishes are carried out after his death without being subject to
outside attack. A trust allows the founder to control his wealth while he is alive and after his death through written instructions to his succeeding trustees.
A trust offers protection from claims by the founder’s personal creditors in some circumstances
A trust protects the financial interests of minor children and other vulnerable beneficiaries
A trust structure can prevent indiscriminate spending of the assets by less responsible heirs to the detriment of others
The trust founder is assured of impartiality between beneficiaries after his death, as the decisions of objective trustees should not likely favour any beneficiary
A trust facilitates multi-ownership of as- sets which may not be easy to split be- tween heirs, such as a farm or block of flats - with a trust the beneficiaries can receive the income generated by the as- set, while the asset itself is held intact in the trust
In certain circumstances income from a trust can be split amongst beneficiaries, thus reducing income tax liability
A trust may have an important role to play in estate planning, even if this is limited to a simple testamentary trust in a Will to protect minors’ inheritances; for the wealthier estate planner, trusts can be an invaluable tool for numerous reasons.