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How to set up a family trust
What is a family trust?
A trust exists when one person (a "trustee") holds and owns property for the benefit of another person (a "beneficiary"). A family trust is a trust set up to benefit members of your family.
The purpose of the family trust is for you to progressively transfer your assets to the trust, so that legally you own no assets yourself, but for you, through the trust, to still have some control over, and get the benefit of, these assets.
You can set up a family trust either while you are still alive (by a declaration of trust contained in a trust deed) or when you die (by the terms of your will). This HowTo sheet is mainly concerned with trusts created while you are alive, and with the benefits that these trusts can provide for you in your lifetime.
What are the key elements of a family trust?
Like any other type of trust, a family trust must have the following elements:
- The settlor - This is the person who sets up the trust, and is usually also the person who currently holds the assets that will be transferred to the trust. In other words, this is you. There may be more than one settlor: in the case of a family trust, a married couple may both be settlors.
- The trustees - The trustees are the people who are responsible for administering the trust. They must make sure that the wishes of the settlor (as set out in the trust deed) are carried out.
You, the settlor, are normally allowed to also be one of the trustees of your trust. Usually the settlor will also appoint an independent trustee, which is often the settlor's lawyer or accountant. Having an independent trustee helps avoid any suggestion that the settlor continues to have control of the trust assets, in which case Inland Revenue may argue that the trust is a "sham" and therefore invalid. For more on trustees, see How to understand trusts and How to be a trustee.
- The beneficiaries - These are the people who may benefit under the trust. With a family trust, the beneficiaries will normally include every member of your family (including possible future family members such as future grandchildren).
These beneficiaries are all "discretionary" beneficiaries, which is a key factor in family trusts. Discretionary beneficiaries (unlike the beneficiaries under a "fixed' trust) have no right to receive any benefit under the trust; instead, the trustees have a power to choose which of these beneficiaries will receive the benefit of any assets. The trustees are free to decide who is the most deserving beneficiary from time to time.
- The trust deed - This is the legal document that states the settlor's wishes and sets up the trust. It appoints the trustees and states their powers and duties, states the beneficiaries, and states various rules for the administration and management of the trust. In order for the deed to be clear and to meet certain tax requirements, it must generally be a lengthy and carefully drafted document.
- The trust's assets - The trust must have some assets. When the trust is first set up, these assets will usually only be nominal â€“ say $10. But the eventual aim is for the trust to hold all of your significant assets.
The goal of a family trust: Your "personal poverty"
The goal of setting up a family trust is to transfer your significant assets from personal ownership to ownership by the trust â€“ in other words, to achieve "personal poverty" while becoming a beneficiary of the trust yourself.
By doing this, you may succeed in protecting your assets from threats from various directions, such as claims by business creditors, or claims by ex-spouses or partners under the PROPERTY (RELATIONSHIPS) ACT 1976. For more details on these and other threats to your assets, and how a trust protects against them, see How to understand trusts (under "Reasons for Forming a Trust").
By what age should I have transferred my assets to a trust?
To get the maximum benefit from your trust, you should aim to have your significant assets in a trust by age 55 at the latest. It's therefore normally recommended that people in their forties and fifties should be considering the advantages of a family trust.
As an illustration, if a single person aged 70 to 80 proposed gifting assets of, say, $200,000 to a trust, they would need to live another eight years to forgive the debt at $27,000 each year, and then another five years before qualifying for government rest home subsidies. (This is explained below under "Transferring Your Assets to the Trust" and "Rest-Home Subsidies & Gifts to Family Trusts".) At that advanced age, this may well be overly optimistic. It's likely that the person would need to seek care well before those time limits expired and the gifts were completed.
But even if you do not transfer your assets to a trust by age 55, a trust can still provide you with benefits, as is explained below: see "Rest-Home Subsidies & Gifts to Family Trusts /Can a trust help even when rest home care is impending?"
The costs of maintaining a trust
There are likely to be overheads in maintaining a trust. If the trust holds income-earning assets, the trustees must maintain annual accounts and annual tax returns and comply with any other requirements imposed by the Inland Revenue Department. It is therefore important to establish, before you set up a trust, that the benefits of the trust will outweigh the costs.
Transferring Your Assets to the Trust
What assets can or should be transferred to the trust?
Almost any assets can be held by the trust, including real estate, motor vehicles, valuable artwork, household items such as furniture, and company shares.
You should usually consider transferring appreciating assets into the trust before depreciating assets (such as motor vehicles). But this depends on your age, how you intend the trust to be used, and your personal circumstances. You should get expert advice on this.
The steps for transferring your assets to a family trust
Once the trust has been formed, the steps involved in transferring assets to the trust are as follows.
- Choose the asset to be transferred to the trust - This would usually first be the family home. But as explained above, you can also transfer holiday homes, boats, vehicles or paintings â€“ indeed any assets that you personally own.
- Obtain valid and acceptable valuations for that asset - Usually you will need to get a market valuation for the house or other asset. In some cases there will be several different methods of determining the market value; it can often be worthwhile to use all the methods available and then take the lowest valuation.
The values should ideally be fixed by an independent valuation - for example, by a Registered Valuer for real estate, by Stock Exchange sale values for equities, and by independent expert valuation of government and other registered stocks and debentures.
- Transfer the ownership of the assets in exchange for a debt - Typically you would make an Agreement for Sale and Purchase of the house or other asset to the trust.
The trust must pay you, the seller, the full value of the asset - if the family home is worth $200,000, the trust must give you a cheque for $200,000. But usually a family trust will have been set up with only nominal assets (say, $10), and cannot afford to buy the home. So you the seller will lend the trust $200,000 as an interest-free loan. This is effectively a paper transaction - the loan and the payment cancel each other out, and so you do not need to borrow any money from your bank.
The debt to you is recorded in, and is secured by, a Deed of Acknowledgement of Debt, made by the trustees.
- Forgive the debt - At the end of the previous stage, the asset has passed to the trust, but the trust owes you a debt for an equivalent amount. A debt owed to you by the trust is still a personal asset of yours, so you have not yet succeeded in divesting yourself of significant assets. The solution is to forgive the debt to the trust â€“ this is done in stages over several years, by a "gifting programme", so as not to incur duty on the forgiveness of the debt. Each stage is effected by a Deed of Partial Forgiveness of Debt. This process of forgiving the debt, and why it is necessary to do it by stages, is explained in more detail under the next heading.
Once the debt has been fully forgiven, you have achieved "personal poverty" in relation to that house or other asset. You no longer own it â€“ the trust now owns it. But you can still receive a benefit from it as a beneficiary under the trust.
The "gifting programme": How to forgive the debt to the trust
When you forgive a debt to the trust, this amounts legally to a gift. New Zealand tax laws limit the amount that any one person may gift each year, without incurring gift duty, to $27,000.
If a married couple transfers assets to a trust, they can each take advantage of the $27,000 a year limit, and therefore gift a combined $54,000 a year.
For gifts above $27,000, gift duty is payable at the following rates:
- $27,001 to $36,000 - The gift duty is 5 percent of the excess over $27,000.
- $36,001 to $54,000 - The gift duty is $450, plus 10 percent of the excess over $36,000.
- $54,001 to $72,000 - The gift duty is $2,250, plus 20 percent of the excess over $54,000.
- Over $72,000 - The gift duty is $5,850, plus 25 percent of the excess over $72,000.
If the value of the assets being transferred is more than $27,000 for each person, the debt incurred by the trust when the assets are transferred to it cannot by forgiven all at once without incurring gift duty. It must therefore instead be forgiven in stages.
This process of forgiveness of debt by stages is known as a "gifting programme".
An example of a gifting programme
- A couple, John and Marsha, have set up a family trust. They jointly own a house with no mortgage. They want to transfer the house to the trust.
- The couple obtain an acceptable valuation. A Real Estate Agent's appraisal has indicated a market value of $180,000, while a current market valuation from Valuation New Zealand indicates $170,000. The couple choose the lower market value of $170,000.
- The couple then enter into an Agreement for Sale and Purchase with the trustees of the trust for the sale of the house for $170,000.
- On the settlement of the transfer of the house from the couple to the trust, the trust pays $170,000 to the couple and in exchange receives $170,000 as an interest-free loan. At this point, the trust is now the owner of the house, but the couple still have a personal asset (the loan) of $170,000.
- The couple now start the process of forgiving the debt. At each stage this is done by them making a Deed of Partial Forgiveness of Debt:
- In the first year John and Marsha each forgive the maximum allowable $27,000 of the debt owed to them by the trust, a total of $54,000. This reduces the trust's debt to the couple to $116,000.
- In the second year, the couple forgive a further $27,000 each, so that the total debt owed by the trust to the couple is $62,000.
- In the third year, the couple forgive a further $27,000 each, so that the total debt owed by the trust to the couple is $8,000.
- In the fourth year, the couple forgive the remaining debt of $8,000.
- The trust now owns the house and the couple is no longer owed any debt. The full transfer of the asset to the trust using the gifting programme is complete. The couple can correctly and legally declare that they do not own the house, if called on by a creditor or other person to make such a declaration.
Do I have to notify IRD of any gifts?
Inland Revenue requires you to fill in and send them an IR 196 "Gift Statement" form whenever you make gifts totalling more than $12,000 in any 12-month period. You will therefore need to send them an IR 196 if you make a Deed of Partial Forgiveness of Debt to a family trust (if the reduction in debt is for more than $12,000). You should send two copies of the form, along with a copy of the deed of forgiveness. You can get a copy of an IR 196 form from the IRD website at www.ird.govt.nz (under Forms, Books & Newsletters/Duties).
A "lease for life": An alternative to outright sale of the family home to a trust
A recent trend has been for people setting up a family trust to grant themselves a life interest in an asset â€“ such as a lease for life over the family home â€“ before they sell the asset to the trust.
This is an alternative to the conventional approach for dealing with the family home or other significant asset in family trust arrangements, which is for the settlors to sell full ownership of the house to the trust, and lend the trust the money for the sale. The trust owns the house, but leases it back to the couple, who pay rent to the trust.
With a lease for life, by contrast, the settlors grant a lease for life to themselves to occupy the house, through a Deed of Lease for Life to Occupy Building, and then sell the trust the "reversion" â€“ that is, what's left of the ownership rights in the house after the settlors' right to occupy it during their lives. So, unlike the conventional approach, the trust does not get outright ownership of the house. And unlike the conventional approach, the settlors' right to live in the house comes not from a lease given by the trust, but from the lease for life that the settlors granted themselves before the trust obtained any ownership rights in the house.
The purpose of choosing the lease for life approach is to reduce the value of the asset that is transferred to the trust. If a person has a right to use an asset for the rest of his or her life, then that asset is immediately worth less to someone else â€“ in this case, to the trust. The settlor should obtain a valuation of the property before the sale to the trust; the value will be much less because of the lease for life to the settlors.
For example, if a life interest (a lease for life) in a property is created for a 60-year-old woman, the property is now worth 40 percent of what would be the market value if there were no lease for life â€“ in other words, a $200,000 house could be sold to the trust for $80,000.
When should a lease for life approach be used?
Although the creation of a life interest in a property sounds like a miraculous cure to advance the gifting programme, it does have some significant drawbacks in practice. It is therefore useful only in certain narrow circumstances. Factors that will be relevant include:
- the value of the property
- the age by which the settlors wish to have completed the process of gifting their assets to the trust
- the likelihood of the trust needing to sell the property (which may in turn depend on the nature of the property, such as whether it's a beach property)
It's important that anyone who is considering using this technique, or indeed any other type of family trust arrangement, gets full legal advice.
What if the property I want to transfer is subject to a mortgage?
A mortgage over the property can make the necessary transactions more complicated and therefore more costly, but it imposes no real barrier to transferring the property to a trust. For more detailed information on this, get legal advice.
Can a transfer of assets to a trust be set aside?
Yes, certain Acts of Parliament do provide for transfers of assets or gifts to be set-aside in certain circumstances:
- Property Law Act 1952 - A transfer of property may be set aside if the intention in transferring it was to defraud creditors.
- Insolvency Act 1967 - A payment of money can be taken back if you are adjudged bankrupt within two years of that gift being made, or within five years if it can be shown that at the time you made the gift you were unable to pay your debts.
- Property (Relationships) Act 1976 - Under this Act transfers of assets can be set aside if the effect of that transfer is to defeat the rights of spouses or de facto partners to share in the couple's relationship property.
- Social Security Act 1964 - This is the Act that is relevant to rest home subsidies (Residential Care Subsidy). Unlike the other Acts listed above, its effect is not to overturn the gift but rather to provide for the government to refuse to grant a benefit in some cases where a gift has been made. This is explained in more detail below.
Rest-Home Subsidies & Gifts to Family Trusts
Asset-testing for the Residential Care Subsidy
People going into long-term rest home care can apply for the Government to pay for their care by way of a Residential Care Subsidy.
The most important requirements for qualifying for this subsidy are that -
- you have no home (unless your spouse or partner dependent child is still living in your home), and
- your cash savings are less than the set limit
The asset threshold increased dramatically on 1 July 2005, from $15,000 to $150,000, and after that increases by a further $10,000 on 1 July each year. However, by 2010, for example, the asset limit will still be only $200,000 (for a single person), and any assets over that amount will go towards rest-home fees. Therefore, there are still significant benefits to be obtained in this area by transferring your assets to a trust. Also, there remain other important arguments for transferring your assets to a trust, besides Government asset-testing: see How to understand trusts.
Note that you are allowed to reduce your cash assets by pre-paying a funeral up to the value of $10,000.
The five-year time limit for gifting
When you apply for the Residential Care Subsidy, you must sign a declaration that answers the question, "Have you made any gifts within the previous five years?"
A forgiveness of debt under a family trust arrangement is a gift. This means that the debt owed by the trust must have been completely forgiven more than five years before you apply for the Residential Care Subsidy in order for you to be able to answer "no" to this question.
If you have made any gifts within the previous five years that total more than $5,000 per year, the excess over $5,000 a year is treated as part of your assets when you apply for the Residential Care Subsidy, even though you no longer in fact have that asset.
You get the benefit of the $5,000 a year deduction for each year since you made the gift. So if you gifted $30,000 four years ago, you get the benefit of a $20,000 deduction (four times $5,000), so that only $10,000 of the gift is assessed as part of your current personal assets.
Work and Income's powers to look back further than five years
Work and Income have wide powers to investigate gifts made earlier than the previous five years, going as far back in time as they like. If they decide a gift made at any time was made so that you would qualify for a benefit or subsidy, they can assess it as still being part of your personal assets and refuse you the benefit or subsidy on the basis that your personal assets are more than the allowable maximum.
- It's not enough simply that you form a trust and transfer assets to it. It's essential that the trust is properly administered, that records are kept and that the trust assets are dealt with according to the terms of the trust. Otherwise, the trust could be held to be invalid through investigations by the Inland Revenue Department or some other creditor (including Government departments). For more information on trusts and the duties of trustees in administering trusts, see How to understand trusts and How to be a trustee.
- Expert legal advice is essential. Bad advice is a waste of money.
Relevant forms and documents available free on the web
- IR 196 "Gift Statement" - Inland Revenue requires you to fill in and send them an IR 196 "Gift Statement" form whenever you make gifts totalling more than $12,000 in any 12-month period. You will therefore need to send them an IR 196 if you make a Deed of Partial Forgiveness of Debt to a family trust (if the reduction in debt is for more than $12,000). You should send two copies of the form, along with a copy of the deed of forgiveness. You can get a copy of an IR 196 form from the IRD website at www.ird.govt.nz (under Forms, Books & Newsletters/Duties).