What is a trust and how does it work?

A trust is created when a person (settlor) gives property to another person (trustee) to hold for the benefit of a third person (beneficiary).

A trust is a legal way to hold and protect your assets for the future. A document called the trust deed is the set of rules for the operation of the trust. It sets out who the beneficiaries are, who the trustees are and how the trust will be administered. Trusts can hold assets, invest and borrow money, and operate businesses. They also pay tax.

Who’s Who in a trust?

Settlor – a person who creates a trust by transferring assets to trustees subject to the provisions of a trust deed

Trustees – the people appointed by the settlor to hold legal title to trust assets for the benefit of the beneficiaries. Trustees have legal control of the trust assets and manage them as instructed in the trust deed. Their decisions must be unanimous. The settlor can be a trustee.

Beneficiaries – the people entitled to receive the benefits from the trust. The trust deed may include:

  • Discretionary beneficiaries, who may receive a benefit from the trust at the discretion of the trustees
  • Final beneficiaries, who are entitled to the funds in the trust when it is wound up
  • Primary beneficiaries, who are discretionary beneficiaries who have been given a priority ahead of the other beneficiaries.

How does a trust work?

After you set up your trust, you sell your assets to the trust at their current market value. Once the assets are in the trust, any increase in their value belongs to the trust.

The purchase price can be recorded as either a gift to the trust or as a debt owed to you by the trust. If a debt, it can be eliminated by an immediate gift or reduced over time under a gifting programme. The option that best suits you will depend on your personal circumstances and reasons for establishing the trust.

How is a trust taxed?

A trust must file an income tax return if it receives income. The trust’s income can be distributed to beneficiaries or treated as trustees’ income or a mixture of the two.

Trustees’ income is income that the trustees elect to retain in the trust and is taxed at the trustee rate, which is currently 33%. Trustees’ income is added to the trust fund and can be distributed tax free to beneficiaries in future years.

Beneficiaries’ income is income that the trustees distribute to the beneficiaries. The income is taxed at the beneficiaries’ personal tax rates (subject to the “minor beneficiary rule” which taxes most distributions to children aged under 16 at the trustee rate).

There could be tax savings if a beneficiary’s personal tax rate is lower than the trustees’ rate, but this should not be the primary reason for creating a trust.

Accessing funds from the trust

There are several ways to withdraw money from a trust.

Income distributions – these are at the discretion of the trustees. Subject to the Trust Deed, the trustees may:

  • Accumulate and retain all or part of the income within the trust (trustees’ income)
  • Distribute income to any one or more of the beneficiaries in any proportions (beneficiary income)

Capital distributions – the trustees may exercise their discretion to pay capital to any one or more of the discretionary beneficiaries.

If the trust owes you money, you may be able to demand repayment of all or part of the loan, subject to the terms of the loan agreement.

The trustees may lend funds to you. They should ask you to sign an acknowledgement of debt or loan agreement.

Trust administration

Your trust achieves its objectives by separating ownership of your family’s assets from you personally. The trust must be administered properly to make this separation of ownership clear.

In general, trustees should:

  • Open a separate bank account for the trust and ensure that all trust income is banked into the account and all trust expenses and distributions are paid from the account
  • Ensure that the trust bank account is not used for personal transactions
  • Ensure that all investments are recorded
  • Meet on a regular basis, at least annually, to review the trust investments and the needs of the beneficiaries
  • Be involved in all trust decisions and record their decisions in writing
  • Comply with the legal obligations imposed on trustees
  • Ensure that annual financial statements are prepared
  • Ensure that the trust meets its tax obligations.

With proper administration, there will be less chance that IRD, creditors or unhappy beneficiaries can successfully attack the trust.

When should I start?

The sooner the better because:

  • The growth in the value of your assets will belong to the trust and not to you personally
  • A trust cannot be used to avoid current and legitimate claims against you by the IRD and business creditors. You need to have created the trust and transferred your assets into it before such claims arise.
  • Less risk of successful relationship property claim if you have created the trust and transferred your assets into it before the relationship began.

Contact us today for a no obligation discussion to learn more about trusts and how they can help you. We have extensive experience and expertise in trusts and will work closely with your lawyer to get the best structure for you.

More information

Benefits of a Family Trust

The Trusts Act 2019 – Trustee duties and beneficiary rights

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