Trusts offer a number of benefits as an estate planning tool, from lowering or deferring taxes to providing a more flexible method of distributing assets. Here is a brief overview to understanding the basics of how trusts work.
A trust is created when you as the settlor transfer ownership of certain assets to a trustee who holds and manages the assets for the benefit of the beneficiaries. For example, if you transfer your holiday home to your brother in trust for your children, your brother legally owns the holiday home, but your children, and not your brother, are entitled to use it.
Trusts can either be inter vivos trusts, which are created during your lifetime, or testamentary trusts, which are created in your will and take effect on your death.
There are many different types of trusts that may be useful as a part of your estate plan, these include:
· Income trusts. You can create a trust that give the beneficiaries the income earned by the trust’s capital assets (like an investment account). For greater flexibility, the trustee may also be given the right to decide how much income should be paid to the beneficiaries. The trustee may also be given the right to pay part of the capital to the beneficiaries over a period of time.
· Spendthrift trusts. If you have a family member who does not handle money well or what a history of financial problems. You may be concerned about giving this person access to a large sum of money. A spendthrift trust allows you to ensure that the member has the income her or she needs, while preventing the person from depleting the capital.
· Trusts for special needs beneficiaries. If you have a child with special needs, you can use a trust to secure their long-term future. A special form of trust can be created to ensure that the child is not disqualified from receiving disability support benefits.
· Spousal trusts. This is a form of a testamentary trust, that clarifies that earned income of the assets will be paid to the surviving spouse.
· Family trusts. These are useful for income-splitting among family members, particularly if the family owns a business.
· Incentive trusts. An incentive trust may be used to motivate beneficiaries who expect to inherit a large amount of money to lead a productive life. Or to motivate employees.
Advantages of a Trust
Trusts offer many advantages, both to the settlor and the beneficiaries:
· Protection from creditors. Assets that are held in a trust are usually protected from the beneficiaries’ creditor, provided the settlement does not cause the Settlor to become insolvent.
· Money management. If a child inherits a large sum of money at a young age, he or she may not be able to properly manage that money. If the money is held in a trust, the trustee can ensure that the child’s living costs, and other appropriate expenses are covered but can delay distributing the bulk of the funds until the child is older and more financially responsible.
· Gifts to minor children. In many jurisdictions, children cannot legally own real estate until they reach the age of 18 years. If you want to leave assets to a minor child, you must create a trust.
· Dispute resolution between children. Transferring a contentious asset, like a holiday home, to a trust for the benefit of your children allows the trustee to make decisions about that holiday home and can reduce the conflict between your children.
· Protection for a second spouse. A trust can allow you to balance the needs of your children from your first marriage with the needs of a second spouse. You can transfer property to a trust that will provide income to your spouse during his or her lifetime. On your spouse’s death, your children will receive the remaining capital.
Choosing a Trustee
You should choose a trustee as carefully as you choose an executor for your will. Like your executor, the trustee should be someone you trust completely, as this person will be making important decisions about how money will be distributed to your family members. You may want to choose a family member or trusted friend who has the necessary skills to administer the trust. In certain circumstances, such as when the assets are very large or will be held over a long period of time, a professional trust company may be an appropriate choice.
You need to consider very carefully the powers you give the trustee to distribute capital and income to the beneficiaries. You can give your trustee complete discretion to make those decisions, or you can impose some restrictions on them (such as providing dates when the capital is to be distributed). In some cases, such as when the beneficiaries are quite young, giving the trustee broad discretionary powers may better allow your intentions to be carried out.
Flexibility
The trustee mut act in an even-handed and impartial manner, both in investing the trust's assets and in distributing those assets. The trustee is required to weigh the competing interests of both capital beneficiaries and income beneficiaries in making decisions about the trust.
For example, a beneficiary who is entitled to income from the trust might want the trust to invest in volatile stocks where there is a risk to the capital, but also potentially higher dividends, in order to increase their income stream. A beneficiary who is entitled to the capital of the trust might want the trust to invest in conservative investments like GICs, that earn a low return but create no risk on the capital.
In making investment decisions, trustees are governed by the “prudent investor” rule that requires the trustee to consider all options, canvass those options with a with a trained investment advisor, receive written advice from the investment advisor, and invest the assets in a prudent manner. In practice, trustees often invest about 60% of the trust assets in equities and the remaining 40% in low-risk cash or bond type investments.
If you are creating a trust in your will, you will want to discuss both your choice of trustee and the powers you are giving them with your family members at the family conference this is particularly true if you are giving the trustee broad discretionary powers. Your children may be less willing to accept decisions made by a trustee than decisions made by you, so it is important that they fully understand why you have given these powers to the trustee and that the trustee is someone they respect.
Incentive Trusts
Incentive trusts are different from the other types of trusts used in estate planning because their primary purpose has little to do with the distribution of assets. Instead, they are intended to motivate “trust babies” into becoming financially self-sufficient, notwithstanding the fact that they may be the beneficiaries of a substantial trust.
Parents who know that their children will inherit a large amount of money have increasingly become worried about the dangers of “affluenza”. They are concerned that children who expect a large inheritance may be disinclined to pursue higher education and may depend on the trust money rather than their personal resources. Parents may use an incentive trust to encourage certain types of productive behaviour from their children.
Referencing various definitions from Ian M. Hull's 'Advising Families on Succession Planning' Chapter 9 - Trusts text.