Trusts in Estate Planning
A trust is a powerful estate planning tool if it is properly structured and understood. Essentially, a trust is a legal arrangement where an individual transfers assets to a third party (called a trustee). The trustee is bound by a deed to follow a set of directives and rules to hold and manage the assets for the benefit of others (known as the beneficiaries).
The individual who transfers the assets into a trust is known as the settlor or grantor.
The trustee becomes the legal owner of the assets entrusted to him by the settler, but the beneficial interests are with the beneficiaries of the trust. This dual ownership of assets is given recognition and legality under the body of law known as equity.
An example of a trust in operation is shown below:
“Peter inherited S$100,000 from his father’s estate. He would like this money to pay for his only child’s university education. His child, Tim, is still in primary school. Peter worries that unless the money is locked up, he might be tempted to spend it.
His estate planning advisor advises him to create a trust. Peter agrees and names his trust “The Tim Trust”. Under the trust, the money is to be invested by the trustee and not to be released until Tim is admitted into a university. Peter and his wife appoint John, their trusted friend and Tim’s godfather, as the trustee. John is happy to act as trustee.
After the deed is executed, Peter pays S$100,000/- into the bank account that has been opened in the name of the trust and is operated by John as trustee.”
The example shows the basic elements of a trust in operation. The elements may be represented as follows:
The main advantages of trust in estate planning are as follows:
- Trust is a non-probate and private instrument
- Assets in an irrevocable trust are protected from the settlor’s creditors
- A trust can be structured to distribute assets to a beneficiary periodically
- A trust can ensure the right person benefits from the assets
Trust is a non-probate and private instrument
A trust can be seen as a transfer of wealth. The settlor transfers the ownership of his assets to the trustees, who in turn manage the assets for the benefit of the trust beneficiary. Therefore, the assets inside the trust are not subject to probate when the settlor dies.
It is not un-common that the probate or administration process during estate settlement take a long time. During this estate settlement process, the assets of the deceased are frozen. The family members’ livelihoods can be seriously affected.
As the trust assets do not fall under the deceased person’s estate, such assets need not go through the probate process when the settlor dies. The trustee can provide the needed liquidity from the trust assets for the family.
Another advantage of a trust is its confidentiality. A trust is a private arrangement, unlike the will which becomes a public document when the testator dies. The confidentiality of a trust is an important feature when you do not want the exact details of the assets to be made known to other parties.
Take the example regarding Peter and “The Tim Trust”. If Peter dies unexpectedly, the $100,000 in the trust will not need to go through the probate process, and the details of this asset are provided only to those who need to know.
Assets in an irrevocable trust are protected from settlor’s creditors
This is another reason why assets are placed into trust. Creditors can come in many forms. You can come into contact with creditors after failing to honour a personal guarantor over a corporate loan; losing a law suit of negligence; experiencing business failure; or just simply being unable to make good a debt.
Take for example “The Tim’s Trust” as described above, if Peter did not place the $100,000 into an irrevocable trust, and assume he is slapped with a bankruptcy charge over a loan of which he is the personal guarantor. The $100,000 can be claimed by the creditor and the intention of sending Tim to university will be destroyed.
If the trust is structured as an irrevocable trust, the creditor cannot claim the $100,000 inside the trust, because the assets are ring-fenced by the irrevocability of the trust.
The benefits of asset protection in an irrevocable trust are undisputed, but the take up rate is low. This is because of the ignorance of the creditor’s risk in one’s life. In the 1990s, a few high net worth individuals were invited to be directors of a non-profit organisation. These individuals were at the peak of their careers, and took up the directorship in a volunteer basis without fee. In 2004, these directors were charged in court over negligence of director duties, and were sued heavily for loss of potential donation to the non-profit organisation. Unable to make good the court judgment, they were made bankrupt by the creditor. Their assets were subsequently liquidated, and their families suffered tremendously. This is a classic example of ignoring the creditor’s risk because of one’s ignorance. Therefore, be prudent and ring-fence some of your assets into an irrevocable trust just in case.
Trust can be structured to distribute assets to beneficiary periodically
We want our beneficiaries, usually our children, to be prudent with their finances, and to be grateful when they receive our inheritances, whatever the amount maybe. In reality, it might not be so. Your intended beneficiary could be a subject of a bankruptcy law suit; have weak financial discipline; have undesirable habits like gambling or high living; be facing a divorce trial; or lack the mental capacity to handle money. These are real issues which every parent can identify with, but will rarely talk about openly.
In such circumstances, you need to consider whether to transfer your estate to your beneficiary in one lump sum or in meaningful amounts periodically. In an unplanned situation, your estate will be transferred to your beneficiary in one lump sum.
A trust can be structured to hold and preserve your estate, and distribute a meaningful amount to your beneficiary periodically. The distribution can be fixed or discretionary.
Trust can ensure the right person benefit from the assets
Sometimes, you might not want to make known in your will that you have the intention of providing for certain people in your life. For example, if your elderly parents and your spouse do not get along well, it would be difficult to expect your spouse, who usually would be the executor of your will, to put your elderly parents’ interests at heart. It is not uncommon to see the surviving spouse place her own children’s and family’s interests over your surviving elderly parents when distributing your net-estate.
In this situation, you might want to structure a trust in such a way that your elderly parents’ interests are looked after, without compromising your spouse’s financial position when you die.
Another situation you could encounter is if you have 2 sets of children, for example, one from your previous marriage and one from your current one. It is only natural for your current spouse to place emphasis on her children rather than the ones from your previous marriage. Under these circumstances, if your estate is distributed solely through your will, your first set of children is likely to be disadvantaged. By structuring a trust, you can adequately provide for the children of your previous marriage without causing a misunderstanding with your current family.
Thirdly, if you are in a non-traditional relationship, for example you are a homosexual or are co-habiting with a partner. It would be difficult or inconvenient to distribute your estate through your will, as your family may put forth a legal challenge to your will if they disapprove of your relationship. You might want to structure a trust to provide for your surviving partner in a low profile manner.