Do you really need a discretionary trust?

A trust protects your assets because these assets are held for the benefit of the beneficiaries, not the trustees holding the assets.  This means that if the trusts’ settlor is being pursued by creditors, the creditors only have access to what the settlor owns, not what is in the trust.  Similarly, if the settlor is a director who is found to have breached their duties owed to the company, the company can only have recourse against the settlor’s personal assets, not what is in the trust.  However, gifts made to the trust can be clawed back by creditors if they were made within the last 2 years, sometimes longer.  This means it is important to set up a trust and transfer assets to the trust early if you need to protect those assets.

Trusts can help with acceptable tax planning in some cases.  When beneficiaries have a lower income tax rate (people who primarily care for children being the traditional example), the trust can pay its income to that beneficiary.  That beneficiary income is taxed at the beneficiary’s lower tax rate.  You can take best advantage of this if the trust fund is set up to make substantial income each year such as owning a rental property portfolio paying consistent rent.  However, tax can be complex and hard to get right, so it is best to double check how the rules will apply in your particular circumstances before forming a trust.

A trust can assist with succession planning, especially in a situation where you know that your will may be challenged.  Instead of leaving your assets to be allocated according to your will, you can gift them to your trust ahead of time and let it control what happens to your assets.  This is very helpful in complex family situations, when a lot of money is involved, or the relationships between family members are especially strained.

Who needs to reconsider retaining their discretionary trust?

Anyone who does not substantially benefit from their discretionary trust should reconsider whether it should continue to exist.  These people typically:

1. Have more than 2 trusts;
2. Treat the trust money as their own to use when they like;
3. Do not have a clear reason for having each distinct trust;
4. Do not regularly maintain their trust (eg holding regular trustee meetings and doing correct accounting and tax returns);
5. Do not understand the duties upon the Trustees; or
6. Have no clear idea as to what will happen to the trust fund after they die.

Why should you remove their discretionary trust?

There are considerable costs to keep a discretionary trust running.  Typically, unless you are getting significant advantages from your trust as discussed in the previous sections, it is not worth having a trust.  This is due to the costs required to operate it properly and the risks if you do not operate it correctly.  These costs include:

1. Accounting costs to keep financial records and file tax returns;
2. Time costs to hold trustee meetings and make properly documented decisions;
3. Legal costs to ensure the trust complies with the Trusts Act 2019;
4. Independent Trustee costs such as Perpetual Guardian (if relevant);
5. Providing trust information to all named beneficiaries; and
6. Dealing with any disputes with disgruntled beneficiaries.

There is a lot which can go wrong if you do not correctly manage your discretionary trust.  Some people may wish to get rid of their discretionary trust to avoid these risks.  Some of the scenarios are below:

1. A disgruntled beneficiary successfully sues the trustees for breach of trustee duties so the trustees have to pay for their own legal costs out of pocket;
2. The IRD audits the trust and finds problems with the financial records;
3. The trustees fall out with each other and all decisions are deadlocked;
4. The settlor urgently needs cash and cannot take money out of the trust easily;
5. The trustees inadvertently breach duties like the duty to invest prudently; and
6. The trustees do not know of obligations such as providing basic trust information to beneficiaries and breach the Trusts Act 2019.

K3 Private Wealth team

Protect your current and future wealth with K3.  Our team will help you create robust legal structures to safeguard your current and future wealth.  Setting up robust legal structures now helps ensure they produce the effects that you intended, simplifies management and safeguards you from potential liability in future.  We are experts in the interlocking areas of law required to make these structures effective such as trusts, wills, relationship property, powers of attorney, immigration, and overseas investment.  This is our private wealth team’s sole focus.

We can assist you creating, resolving disputes with, or managing structures like trusts, wills, and contracting out agreements.  We are well versed create family trusts and charities that are fit for purpose, help you manage them effectively, and deal with any potential disputes.  We work extensively with accountants, tax experts, financial advisers, insurers and other experts to protect your current and future wealth.

This article was provided by K3 Legal

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Helen Edwards
Director
027 9443405
[email protected]

Andrew Coffin
Solicitor
021 0634267
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The wider K3 team includes experts in areas like litigation, insurance and family law.  They provide their specialist advice to assist our private wealth team in more complex matters.

Edwin Morrison
Director
021 2435203
[email protected]

Julia Leenoh
Director
021 0340411
[email protected]

Peter Napier
Director
027 4893526
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Patrick Shanahan-Pinker
Senior Associate
021 1403351
[email protected]