An Inconvenient Trust
Nearly every family seems to have a trust. But do you even remember why you have a trust? Now that the New Zealand Trusts Act 2019 is requiring trustees to give beneficiaries more information, we believe many settlors and trustees will be winding up or resettling their inconvenient trusts.
Trusts not fulfilling their purpose
Trusts became fashionable decades ago to get around asset testing for rest home subsidies, but laws have changed to penalise people who make large gifts to trusts. Trusts for creditor protection may have been useful when a settlor was operating a business, but if the settlor has sold his or her business, then the creditor risk is no longer there to the same degree. There may still be a reason to protect assets held before entering into marriage, civil union or de-facto relationships but other steps are required (contracting out agreement or pre-nuptial agreements) for the trust to be effective.
More information for beneficiaries
From 30 January 2021, trustees will be required to inform all adult beneficiaries (18 years and over) that they are beneficiaries of a trust, how they can contact the trustees and what information they can request about the trust. Some trusts have children, grandchildren, friends of the original settlors, charities as discretionary beneficiaries. If these discretionary beneficiaries are unlikely to receive distributions while the original settlors and their children are alive, should they be beneficiaries at all?
Imagine a situation where trustees had credited income to a child beneficiary to be paid out at a future date. When the children became adults, they would see the financial statements and ask where their money is. Would they understand that the money is tied up in stocks or property? Or would they demand to be paid out immediately?
The trustee duties in the Act have already been established in case law and shouldn't be considered onerous, yet some trustees are surprised by what is expected of them. Trustees should be aware of the terms of the trust, act honestly and in good faith in accordance with those terms, to the benefit the beneficiaries or to further the purpose of the trust. Trustees must exercise their power for a proper purpose.
The maximum duration of a trust (the perpetuity period) has been extended from 80 years to 125 years. At least one trustee needs to hold all the core trust documents and keep them updated.
There are also default duties which can be modified when the trust is established: duty of care, investing prudently, not to exercise power for own benefit, avoiding conflict of interest, acting unanimously. This allows the settlors more say in how the trust operates when it is turned over to the trustees.
Tax consequences for unwinding the Trust
If you decide to unwind your trust, there may be tax consequences. For disposing of property, plant & equipment, there may be depreciation recovery which is taxable income. Resettling property into new ownership will restart the clock for the five-year bright-line test. If the trust is a shareholder in a Look Through Company or partner in a partnership, there is a deemed disposal which may have tax consequences. In addition to the tax cost, there is also the legal cost of transferring property.
What steps to take
We suggest that it's important to have money conversations with your children as early as they are old enough to understand. Help them to understand budgeting and stewardship. Saving for a rainy day. Investing for growth. Then when they find out they are beneficiaries of a trust they can understand that it doesn't mean they can have the money to spend.
Review your trusts with your accountant and lawyer. Why do you have them – for asset protection from creditors, from relationship partners? Do they still achieve their purpose? Do you need to make your beneficiary criteria narrower? If you are a trustee, are you aware of your duties? Are the trustee duties and terms of the deed in line with the new Trusts Act? Consider the tax consequences for unwinding the trust. Don't wait until 30 January 2021 to do something about your inconvenient trust.
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- Serena Irving
Serena Irving is a director in JDW Chartered Accountants Limited, Ellerslie, Auckland. JDW is a professional team of qualified accountants, auditors, business consultants, tax advisors, trust and business valuation specialists.