Have you heard of “Trust Fund Kids” or people saying you should buy a property in a trust? It sounds marvelous but what exactly is a trust and why would you want one? (And if you’re interesting in buying a property to rent, please have a look at these 6 myths about buying to rent)
In this post we’ll look at what a trust is, the pros and cons of a trust, and how one can go about starting a trust (if you want to). Note though that this is written from a South African perspective but the general concept is applicable in most countries. Also note from the outset that operating a trust costs money and consists of a fair bit of admin so don’t think of it as a quick solution to any problems you may have.
What is a Trust?
A trust is really just a legal contract between 3 parties. The parties can be the same person (or group of people) or they can be totally different. As with any legal contract, one can get a good, well written and detailed contract, or one can get a generic and possibly inadequate one. So the actual contract, wording and definitions of everything is really important! There should be no ambiguity in what is meant!
The parties involved in a trust
Basically though, the 3 parties involved are “The Founder“, “Trustees” & “Beneficiaries“. Because this is a legal contract, there is no right or wrong way to set it up in the sense that you could make only one person a beneficiary (such as a child), you could be a beneficiary yourself, or it could be a group of people including future descendants. The contract needs to be drawn up by a trust expert who understands what your reasoning is and what the purpose of the trust will be.
If any of the parties are no longer identifiable, then the trust will cease to exist. What that means is that if you state that your son is the only beneficiary, then the trust will need to be closed down once your son passes away. Thus, how you define things and word things is very important!
Back to the three parties though
The founder is the person who has the intention to set up the trust. This is generally yourself but it could be a parent if you are assisting your parents to set up a family trust.
The trustees are the people who are responsible for the operating of the trust and these people must be in good standing with the law. They have legal obligations and must ensure that everything is run correctly. Generally speaking you would want yourself or someone you trust as a Trustee, but it is also a legal requirement to appoint an independent trustee who has absolutely no benefit from the trust. This person would most probably need to be paid a monthly fee (unless you have a good friend) and ideally the person should have a legal background to assist you in making sound decisions.
The beneficiaries are everyone who will benefit from the trust. These could be currently living people or future descendants.
The concept of a trust
Once you have the Trust Deed in place (the contract) the trust is it’s own legal entity and is required to open its own bank account and register with SARS (local tax authority). From now on, anything that is donated to the trust is now owned by the trust.
So if you have a trust and donate R20,000 to the trust, that money is no longer yours and you cannot simply spend it as you want. Any expenditure, transactions, decisions, etc must be made by the Trustees and jointly agreed to. A proper Trust Deed will include a section on managing disputes, but the main point to understand is that the Trust operates as it’s own entity and you do not own anything that is held in Trust.
The beneficiaries however could benefit from the trust (either with money, having expenses paid, or having use of assets). If the trust is set up as a discretionary trust, then it would mean that beneficiaries have no entitlement rights to the trust, but their benefits are decided solely by the Trustees whose job it is to manage the trust as best they can according to purpose of the trust as set out in the Trust Deed.
Why would you want a Trust?
The single biggest reason to have a trust is to protect your assets and to build a legacy. As described above, a Trust is a separate legal entity. So if the trust owns a car that you are allowed to drive, then that car really doesn’t belong to you. If you go bankrupt in your personal capacity, the assets owned by the trust are not affected and remain untouched by creditors (people you owe money to), provided the trust administration was done to the book, otherwise the trust could be seen as a sham and a way to defraud the people you owe money to.
The same goes for a property that the trust owns. You could potentially be bankrupt but remain living in the same property with the same furniture and drive the same car, all because you don’t own the items and they cannot be repossessed. See the post on why buy a property in a trust.
Protecting your assets also means that you can build a legacy through generations of family. If the trust owns the property that your parents live in, and they pass away, there are no estate duties, taxes or anything relating to that property. The reason is that the trust is a separate entity and if the trust owns the property, then it has nothing to do with the individuals living in it.
Important note: Your assets are only protected in a trust if you operate the trust exactly as the law dictates. The next section gives an overview of how to operate a trust, but any slip-up and poor administration can make your trust useless. From the outset the Trust Deed must be set up by a real expert who understands what your purpose for the trust is.
How do you operate a Trust?
Operating a trust is relatively simple but it does involve some administrative skills. An annual meeting of trustees is required along with the signed minutes. And all decisions and expenditures require a formal resolution signed by the trustees.
Financial statements are to be produced each year and full compliance with regards to tax returns. Anything that is not 100% correct could compromise the whole trust.
On the practical side, the trust has a bank account and you could have a card linked to it. The trust owns assets which various beneficiaries have use of and it’s a bit like running a company. You just need to account for everything and ensure that there is clear communication between all trustees when decisions and plans are being made.
The pros and cons of having a Trust
Some of the main advantages of starting a trust can be:
- Your assets are protected *
- No estate duties are due when you die as the assets do not belong to you anyway *
- The trust is untouched when you die. Bank accounts are not frozen, and assets are left untouched *
* Note: it all depends on how the Trust Deed (legal contract) is set up
The disadvantages of trusts are:
- They cost money to run as you need to have accountants and an independent trustee (usually a legal expert)
- You do not have control over assets in the trust as you need to discuss decisions with trustees
- They involve admin
How to start a Trust
If starting a trust interests you, I would strongly suggest discussing this with a Financial Advisor who really understands trusts and possibly even acts as a trustee on a trust (I can give you my guys number if you want). You will then need to find a reputable company managing and dealing with trusts.
Although all lawyers know about trusts and understand them, not all lawyers focus on trusts so you should find an expert in the field who specialises in trusts and be sure to discuss all details and understand everything before hand! The Trust Deed is vitally important!
Trusts offer an amazing way to protect your assets and to keep wealth within a family. Over the long term I feel that the costs, time & admin involved in operating a trust are definitely worth it and you will see the benefit in the long run, but depending on your current financial status, possibly not in your own lifetime.
As with all things, start small! If you are just starting the journey of taking charge of your money and you have debt, poor financial habits, no savings, etc… then you should probably avoid trusts for a while. Keep them in the back of your mind until such time as you’re actually starting to build wealth and you have a solid investment plan.
As always, discuss your financial plans with a trusted financial advisor. I’ve know my advisor for almost 10 years now; it’s worth building a personal relationship!