Think twice before winding up your family trust

2 July 2021

reading time:  minutes

Family trusts are less popular than they used to be.

There are various reasons for this. Tax benefits are more limited than they once were. Nor are trusts especially helpful in improving your eligibility for Government benefits that are means-tested (eg Residential Care Subsidies).

There have also been some overly broad interpretations of recent cases that have led to some clients believing (incorrectly, in my opinion) that properly established and maintained trusts are weaker than they used to be. A good example of this is Clayton v Clayton – this was a case decided based on very specific facts which are not widely applicable for most trust situations.

The costs of administering trusts have also risen. Although this is often attributed to new legislation coming into force this year (the Trusts Act 2019), I personally think of this Act as codifying much of what was already in place (via common law rather than statute). It has, however, been a convenient excuse for trustees who have woken up to the real responsibilities of acting properly as trustees, and either want to get out of these roles or want to start charging appropriate fees for taking on this responsibility.

As a result, I’ve seen quite a few people who have wound up their trust when they should have kept it – or who have been lucky to retain their trust, despite advice to the contrary.

Two recent examples:

  • Relationship property protection. I recently had a client who had also received advice from a prominent person in the financial advice industry. Although this adviser was not a lawyer, they recommended that the client wind up their trust. The client was in a de facto relationship entered into long after she established the trust. Soon after, the relationship ended. If she’d wound up the trust, at the advice of this person, her assets would have been exposed to relationship property claims. Eek!
  • Bright-line test implications. Just before working with me, some clients had wound up their family trust. One of the assets of the trust was a rental property. It should have been obvious at the time that there was a good chance that these clients would want to sell this rental property at some point in the near future, in light of their age, stage, and broader circumstances. Their lawyer had not pointed out that winding up the trust and resettling this property into their personal names would start the clock in relation to the bright line test – which had recently increased from 2 years to 5 years. Since going unconditional on selling the property, they’ve realised that they will have to pay quite a bit of tax on the proceeds. (It didn’t help that the property wasn’t given a value at the time of the resettlement, causing additional issues that these clients are still working through.)

Yes: the costs of trusts are higher than they used to be. And yes, some of the arguments in favour of trusts aren’t as strong. However:

  • As I explain as a coda to this article, higher costs are arguably a good thing. It means professional trustees are taking this important role seriously, and that you’re more likely to get the actual benefits of the trust if you ever need them.
  • The benefits that aren’t so strong (tax benefits, better access to Government benefits) have very rarely been the most compelling reasons to have a trust in the first place.

Trusts still provide some enormous benefits for the right types of people. Trusts can be tools for:

  • Asset protection.
  • Relationship property protection.
  • Effective succession planning.

If someone tells you that you should wind up your trust, it might be appropriate to do so. Just give it some thought – and in particular, consider whether and to what extent benefits like asset and relationship property protection could still be applicable to your situation.

 

Coda: If you have a professional trustee – pay them!

Note: I am NOT interested in acting in a professional trustee capacity. I don’t have the interest, or the risk tolerance. I don’t act even act as trustee for close friends or family members. The comments below are not a self-interested sales spiel.

For many Kiwis, trusts are a great idea, and can provide a great deal of asset protection.

But trusts are like puppies. As Vicki Ammundsen writes:

“the settlement of a trust can be likened to that moment in the pet shop where this adorable puppy all paws and nose and licky tongue and waggy tail and soulful eyes uses its artillery of cuteness to attack all logic and before you know it you are at the counter with your wallet out and your defences down. 

But what next?  The puppy will need to be walked and taken care of, no more spontaneous let’s go to a movie, let’s … the puppy will need to be cleaned up after, and the only thing that might save the puppy’s life as you try to find a single matched pair of unchewed shoes is that it is so cute you just melt and all is forgiven.  Until the next time …

Trusts are like that.  They are a great idea.  Trusts have proven themselves over time as the best form of long-term intergenerational asset protection.  But trusts like puppies, do not enter your life fully formed.  They take time and effort – and the wallet gets pulled out of your pocket or purse or hand bag a lot. 

If a trust is suitable for you, the first step is to create it. The next step is to maintain it, so it continues to provide the advantages and protections you set it up for.

It’s one thing to get the puppy. It’s another to look after it.

Most Kiwis don’t have the time, energy, inclination, or knowledge to maintain a trust properly. To make sure this happens, it can be valuable to have a professional trustee*.

(*In most cases, a professional trustee is a company with directors and shareholders who know what is involved with administering a trust. This tends to be a better arrangement than an individual acting as trustee. Corporate entities don’t die or lose capacity in the way that humans can. If something happens to an individual acting as trustee, it can result in a LOT of hassle. Imagine, for instance, having a lawyer as your co-trustee in his or her personal capacity, unexpectedly passing away. Remember that this person is likely to be trustee not just of your trust, but many other trusts. Their name will be on the certificate of title for property you hold on behalf of the trust. They will be on accounts with financial institutions. Think about the issues this could cause. Whereas if this individual was the main director of a corporate entity that is properly set up, someone else can step in and continue operating without the same amount of hassle.)

It’s important to note that I distinguish between having a professional trustee, not just an independent trustee.

Most people can be independent. But it is only a subset of these people who have the knowledge and skills to act properly. In this context, you want someone who is not just going to be independent, but act professionally in this capacity.

If you have a professional trustee, you want them to cross i’s and dot t’s. This involves time and expertise. Sometimes they might even have to be a stick-in-the-mud and say things that other trustees and trust beneficiaries may not want to hear. (A defining characteristic of being a fiduciary is that you might find yourself in sticky ethical and moral situations.)

Heck, acting as trustee can be risky. (A good sign you’re dealing with someone who knows what they’re doing: they want lots of indemnities. But even with solid indemnities, being a trustee can be a risky endeavour.)

To my mind, this time, expertise, and professionalism, shouldn’t come free.

In fact, if you have someone who acts as a trustee and doesn’t charge for this, I’d consider this a red flag.

If they’re dotting the i’s and crossing the t’s, spending time and energy in this role, what are they getting out of it? What is their incentive to act rather than do any of the other things they could otherwise be doing?

If you have a professional trustee and they’re not charging you, I’m not saying they’re shirking their duties. But I am suggesting that you might want to consider paying them for this role. Or you should expect them to start charging you in the future.


Tags

asset protection, bad advice, estate planning, fiduciary, relationship property protection, succession planning, trustees, trusts


About the author 

Sonnie Bailey

Sonnie provides financial planning services via his business, Fairhaven Wealth (www.fairhavenwealth.co.nz). Fairhaven Wealth provides independent, advice-only, fixed-fee financial planning services. Sonnie is also a “recovering lawyer”: he has specialised in financial services, trusts, and estate planning.

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