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Plan trusts well or risk the wrath of the taxmanWHEN I wrote about trust funds two weeks ago, I made brief mention of their many uses. Let's take a closer look at them.
Income tax trusts are designed to split an income stream into two or more parts to take advantage of the lower tax rates applied to smaller incomes. One of their most popular uses is by grandparents wishing to provide financial support for the education of their grandchildren. But, contrary to widespread belief, even a parent can create a trust to save income tax, provided the founding assets are sold to the trust at a fair value, and are not donated directly or indirectly.
Estate planning trusts are mainly used to shield a person's wealth from death duties and to hand it on to heirs in a tax-efficient way. But they can meet other needs such as circumventing the delays involved in processing a deceased estate; providing for smooth succession in a private business; and insulating a business from a deceased partner's heir while providing for her or him.
Business trusts offer a way of trading free of some of the inflexibilities inherent in companies and CCs.
Dependant and charitable trusts - the original kind - are primarily to protect the financial interests of the weak or incompetent. Modern social and medical trends create new uses - for example managing the financial affairs of the donor and his/her partner as they grow old (and especially if Alzheimer's threatens), if they have suitable adult children, or their offspring have emigrated. Such trusts may be suitable for:
Offshore and emigrant trusts are a popular tool for international tax planning and can:
A trust is established by a trust deed, which transfers legal ownership of the founding assets. It also defines who will be trustees, how they will manage the assets, who will be the beneficiaries, and how and when the trust will wind up. Where a trust deed specifies the exact way in which the assets are managed, as well as how the benefits will be distributed, a "vested" trust is created - which could have adverse tax implications. For this and other reasons, these days donors usually create a trust that is "discretionary" - one that allows the trustees some or even great flexibility in determining which individuals or entities (such as charities) should benefit and to change them according to circumstance, and what benefits should be paid, among others.
In the case of a discretionary trust, the trust deed usually only sets broad principles on aspects such as how the capital is to be invested and managed, and how the benefits distributed. But the planner may provide a "statement of intent" or "letter of wishes" which, while not binding the trustees, spells out his intentions in greater detail. For example, it may advise the trustees on whether they should treat equally all children who are beneficiaries, or discriminate against a black sheep. Normally a trust deed cannot be changed unilaterally by the planner, whereas a statement of intent can be varied by him at any time. A trust deed should always include a clause enabling the trustees to make changes as they become necessary, including the power to wind up the trust earlier than originally envisaged by its founder. It is possible that trusts will be attacked by the government on the grounds (which have some validity) that they are often tax havens of the rich. Planners who have not granted their trustees the flexibility to counter or escape such an attack could find themselves much worse off than had they not established trusts in the first place. ý Martin Spring is the editor of Personal Finance newsletter
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