How family trusts work and why you'd set one up

Benefits of a family trust

Family trusts are designed to protect our assets and benefit members of our family beyond our lifetime. When our assets are in a family trust we no longer have legal ownership of them – the assets are owned by the trustees, for the benefit of our family members.

People usually set up a family trust to get some benefit from no longer personally owning an asset. A family trust may be useful to:

Protect selected assets against claims and creditors – for example, to protect a family home from the potential failure of a business venture.
Set aside money for special reasons, such as a child or grandchild’s education.
Ensure our children, not their partners, keep their inheritances.
Manage the risk of unwanted claims on our estate when we die – such as from a former partner.

Who’s involved

A settlor: The person or company who creates the trust.
Trustees: The people who manage the trust. The settlor can also be a trustee. It’s also a good idea to appoint an independent trustee who is not a relative. Professionals like lawyers and accountants (or companies they have set up) often act as independent trustees.
Beneficiaries: The people who benefit from the trust, for example members of our family.

Often there is more than one trustee. There may also be more than one settlor of a trust.

The trust deed will state who has the power to appoint and remove trustees. The settlor – or anyone else who is named in the trust deed – can have this power. This is an important power that the person can also transfer to someone else in their will or during their lifetime.

Note that a trust doesn’t usually end with the settlor’s death – it can last for a maximum of 80 years from inception but this is likely to be extended in the future.

How family trusts work

A legal document called a ‘trust deed’ will formally set up the family trust.

It will name the trustees, list the beneficiaries, and state various rules for the administration and management of the trust. The trust deed needs to be very carefully written, preferably by a lawyer.

Asset transfer

Then we will need to decide what things we own should be put into the family trust, and what their value is. In many cases this will be the family home, but other things of value like cash, bank deposits, shares, artwork etc can also be included in the trust.

Once the family trust is formed assets can be sold into the trust, at market value. However, although the trust wants to buy, say, our house (and we want to sell it to the trust) the trust has no money to buy it. How then does the family trust pay for the house?

The answer to this is that we lend the family trust the money. Initially this is a ‘paper’ transaction – we sell the house to the trust, and the trust now owes us a house-sized debt.

However, the debt that the trust owes us is still counted as a personal asset. So we will need to get rid of the debt so we can achieve our aim of owning less in our name.

The way we do this is through ‘gifting’.

Gifting

Most people who form trusts ‘gift’ away the debt that the trust owes them. Before October 2011 there was a limit of $27,000 that anyone could gift in one year without paying a tax called ‘gift duty’ to Inland Revenue. However, gift duty has now been abolished and there is no limit to how much we can gift in one year.

This means that where previously it would have taken 22 years to gift the value of a house worth $600,000 to a family trust without paying gift duty, we can now gift the whole amount of the debt straight away.

If you still owe the money you borrowed to buy the house in your own name then you would not want to gift away the whole debt the trust owes you – because you would have no assets and a large liability. This would leave you insolvent and at risk of being declared bankrupt.

It’s always best to seek legal advice before proceeding with gifting.

Note that gifts are still included in assessment for a Residential Care Subsidy.

For more information visit the Work and Income website.

The costs

Family trusts can be complex and time consuming to administer. It costs money to set them up and there are generally ongoing legal and accounting fees.

It’s worth shopping around, as different organisations charge different amounts both for the establishment and ongoing management of a trust.

Think carefully about who should have the power to appoint and remove the trustees and who the initial trustees will be, as they will be responsible for managing the trust properly. Whoever has the power to appoint and remove trustees should appoint a person in their will to take over the role after they die.

The risks

If a trust is not set up or managed well, there can be considerable inconvenience and cost.

There’s the risk of having the trust declared a ‘sham’, which would mean that the assets are not really the trustees’ but are in fact still ours.

If the trust is a sham we may lose all of the advantages that we were hoping to gain from it, and the trustees may be penalised as well.

Once we put our assets into a trust, we no longer personally own or control them. Instead, ownership passes to the appointed trustees, who must act under the terms of the trust deed in the best interests of the beneficiaries.

There have been cases of family members suing other family members for a breach of the trust’s provisions. The courts treat claims of this sort quite seriously and they will normally be expensive to resolve.

Forming a trust is a big decision. When going down this route, make sure that it is established properly, for the right reasons, and managed well. Keeping clear records of everything that affects the trust is very important.

Getting advice

Family trusts can be quite technical, so we’ll typically need legal, and sometimes accounting, expertise.

Trusts should usually be formed by a lawyer or a professional trustee company.

If using a lawyer, they should be experienced in trust work (lawyers have different specialties and not all of them are experienced with trusts).

Putting property that could qualify as relationship property in a trust? Both partners should get independent legal advice on the implication and effects of that transaction before proceeding.

Good advice on trusts is important. Get professional advice right from the start.

It may seem expensive to get an expert in, but it may cost even more if things are not done well. The New Zealand Law Society provides more information on trusts.