Let’s imagine you own a successful business – a car dealership, perhaps.
One day, you see on the news that the owner of a car dealership is being sued, because he sold a car without doing all the safety checks, and now he’s at risk of losing his family home to pay the damages.
Now you’re worried about the possibility of facing lawsuits or other financial setbacks in the future, too. You want to ensure that your family’s home, savings, and other assets are protected in case your business faces legal troubles.
In this scenario, you can transfer your family home into a trust.
A trust is a separate legal entity, meaning once your home is transferred into the trust, you no longer own it.
Even if you get sued for zillions of dollars, they can’t come after the home, because it’s not yours!
A trust is one of the most popular ways to safeguard your family’s wealth and financial security.
How Does A Family Trust Work, Exactly?
The first step to establishing a trust is when someone has assets they want to protect, and plans to pass these assets on to someone else in the future (usually their children).
This person is known as the trust settlor.
When the settlor creates the trust, they transfer their assets into the trust’s name.
Once this is done, they no longer own the assets, but they do control them.
At the time of the transfer, they must also stipulate who the beneficiaries are.
The beneficiaries are the people who you intend to benefit from the trust, and they will be entitled to the assets in the future. Generally, the beneficiaries are your children.
Finally, the settlor must appoint trustees.
Trustees manage the assets of the trust and have a legal obligation to act in the best interests of the beneficiaries. Often, the settlor is also a trustee, but other additional trustees can be appointed too (such as a husband, wife, grandparent, uncle, lawyer or family friend).
In short, a settlor decides to create a trust, to ensure that his assets will be protected and be passed safely onto the beneficiaries, such as his children. Trustees are appointed to ensure the trust’s assets are looked after and managed properly in the meantime.
Why Establish a Family Trust?
Earlier I described one scenario (the car dealership owner) where a family trust would be useful, but there are several reasons why individuals in New Zealand opt to create family trusts:
- Asset Protection: A family trust can shield your assets from creditors or legal claims, so if you get sued, they can’t come after your family home (since you don’t own it!)
- Estate Planning: It helps in the orderly distribution of assets upon your passing, reducing the likelihood of disputes. If all your assets are owned by the trust, this provides a clear succession plan, since legally those assets already belong to the beneficiaries you have chosen (so nobody else can come after them).
- Tax Benefits: The trust tax rate is 33%, which is lower than the highest individual income tax rate of 39%.
- Privacy: Assets held in a trust are not publicly disclosed, providing a degree of privacy.
How To Establish Your Family Trust
Choose Your Trustees
Trustees manage the trust assets and make decisions in the best interests of the beneficiaries.
You (the settlor) can appoint yourself as a trustee or choose professionals, such as lawyers or accountants, or commonly people choose a combination of both.
For example, a husband and wife can also appoint their lawyer as a third trustee, so there is a trusted neutral party in the case of any disputes.
Common choices for trustees in New Zealand are:
- Family Members: Many people choose to appoint family members as trustees. These could be your spouse, siblings, or adult children. Having family members as trustees can ensure that those closest to you are involved in managing the trust’s affairs.
- Close Friends: If you have friends you trust deeply and who are knowledgeable about financial matters, they can make good trustees. They can provide an objective perspective and expertise.
- Professional Trustees: Some people prefer to have professionals, like lawyers or accountants, as trustees. These experts have experience in managing trusts and can ensure that everything is done correctly from a legal and financial standpoint.
- Corporate Trustees: Another option is to appoint a corporate trustee, which is a company that specializes in trust management, such as NZ Trustees. They have the advantage of continuity and expertise but will charge fees for their services.
- You Can Be a Trustee: Yes, you can be a trustee of your own family trust. Many people choose to be one of the trustees because it allows them to have some control over the trust’s assets and decisions. However, it’s common to have multiple trustees for added oversight and to prevent any conflicts of interest.
- Independent Trustees: As mentioned earlier, it’s a good idea to have at least one trustee who is not closely related to you or your beneficiaries. This can help ensure impartiality and prevent any potential disputes.
Why Consider Multiple Trustees?
Appointing multiple trustees can provide checks and balances within the trust.
It ensures that decisions are made collectively, reducing the risk of any one person making decisions that may not be in the best interest of all beneficiaries. Additionally, it helps distribute the responsibility of managing the trust.
- Trustees should be responsible, honest, and capable of making decisions in the best interests of the beneficiaries (as this is their legal responsibility).
- Make sure that the individuals or professionals you choose are willing to take on the responsibilities of trusteeship. It’s a legal role with specific obligations.
- Communication among trustees is crucial. They should meet regularly to discuss trust matters and make decisions collectively.
- Consult with your lawyer when selecting trustees to ensure that your choices align with your trust’s goals and comply with legal requirements.
Choose Your Beneficiaries
Finally, you need to choose who you’re actually protecting the assets for.
These are your beneficiaries, i.e. the people who will eventually be entitled to the assets in the trust.
In most cases, the beneficiaries are the children of the settlor(s).
Is it possible to be both a trustee and beneficiary of a NZ trust?
Yes! So long as you are not the sole beneficiary and trustee at any time. For example, a common scenario we see is someone names his wife as both a trustee and a beneficiary, and the children as only beneficiaries. This means upon death, all assets will automatically be passed to the control of the wife, for the benefit of the children.
Draft a Trust Deed
Think of the trust deed like a rulebook for your trust. It’s a legal document that outlines the terms and conditions of the trust. It includes:
- Name of the trust
- Details of trustees and beneficiaries.
- Specific assets to be transferred to the trust.
- Distribution rules.
- Provisions for adding or removing beneficiaries or trustees.
- Trust’s duration (max 125 years).
Because the trust deed is a legal document, and the security of your family home and whatever other assets you will be transferring into the trust depends on it, it must be drafted by a lawyer.
Obviously, this will incur legal fees, but it’s worth it to ensure your trust deed is rock-solid and you have peace of mind your assets are safe. Your lawyer will also be able to give his view on your choice of trustees and distribution rules.
Fund the Trust
Transfer your chosen assets into the trust. This process involves legally “selling” your assets to the trust.
For example, to transfer ownership of your family home to the trust, you will sell your house to the trust at market value.
Let’s say the value of the house is $1 million.
You might be thinking, how does the trust buy a $1 million house if it has no assets?
The solution is the trust will buy it with debt, and it’s debt will be owed to … you!
So now your family trust owns the family home, and the trust owes you $1 million.
The final step of the process is for you to “gift” the debt back to the trust.
Before 2011, tax-free gifting was capped at $27,000 per year, but gift duty has since been abolished.
Therefore, you can now gift the full $1 million at once without triggering any gift related taxes.
The end position is the house is now fully owned by the trust, and owes nothing to you. This means you own nothing on paper, though the family home is still fully under your control. Exactly what we wanted!
Again, a lawyer will be required to make sure the process is done correctly (similar to when you buy or sell a house and ownership is transferred), and probably also an accountant to ensure all the transactions are recorded properly.
Register with the IRD And Keep Records!
Your family trust must have its own IRD number for tax purposes. Your lawyer or accountant can assist in registering the trust with the IRD.
You must also maintain detailed records of trust transactions, including income, expenses, and distributions. Proper record-keeping is essential for tax compliance and ensuring the trust’s legal integrity.
Usually an accountant will help you do this, as well as prepare annual accounts and file tax returns for the trust. In fact, when I worked as an accountant this was one of the main responsibilities we had – maintaining trust records for high-wealth individuals.
Be A Good Trustee!
As a trustee, your legal obligation is to act in the best interest of the beneficiaries, not yourself.
For example, let’s assume you transfer all your assets into the trust, and you are the sole trustee and the children are the beneficiaries.
If you use trust money to repair or renovate the family home, this can be justified because your children live in the family home, and it is in the interest of your children that the home is safe and well-maintained.
However, if you use trust money to buy yourself a Porsche, you could be found in breach of your duties as a trustee, as a Porsche is obviously not for the benefit of your children (especially if they can’t even drive yet!)
If you use trust money to take your family on a holiday, then this can be justified, but if you use trust money to just take yourself on a holiday of partying and shopping, this probably cannot.
What I’ve found is it’s not uncommon for trustees to misuse funds (in fact, it happens quite often) and nothing is done about it, but it doesn’t mean it’s right or that it won’t be addressed in the future. Trustees have an important responsibility and must act prudently and responsibly in managing trust assets.
Things that trust funds can be responsibly used for:
- Beneficiary school and university fees
- Beneficiary travel
- Family home renovations and maintenance
- Beneficiary living costs
- Responsible investments
- Payments to beneficiaries for them to spend money as they please.
How Does A Trust End?
A trust is automatically wound up after 125 years, or a date specified in the trust deed.
For example, the trust deed could say the trust will vest (end) when all the beneficiaries have turned 21.
In this scenario, when the last beneficiary turns 21, all the assets will be distributed to the beneficiaries and the trust will cease to exist.
However, trustees can also decide to make distributions to the beneficiaries before the vesting date if they consider it appropriate.
Final Word On Family Trusts In NZ
Overall, the purpose of establishing and managing a family trust in New Zealand is to offer you and your loved ones a range of benefits, from asset protection to tax advantages. However, the process requires careful planning and sound legal and financial advice.
There are over 300,000 registered trusts in New Zealand. If you own a family home and/or other assets, which you would like protected for your children, a family trust is one of the most secure and commonly-used avenues available.
Remember this guide is a simplified introduction to trusts, and your individual circumstances can vary.
This is why it’s essential you have a trusted lawyer and accountant involved in the process. It may be costly but doing it right from the start will save you a lot of potential headaches down the road.