By Ahmad Chahidi, Executive Director – Wealth Planning, Julius Baer (Middle East) Limited
You think that squeezing all of your family’s assets into the same structure will reduce complexity? In our experience, this doesn’t hold true. We have identified seven common mistakes to avoid when setting up a trust.
What is a trust?
A trust is a fiduciary arrangement that allows a third party, or trustee, to hold assets on behalf of a beneficiary or beneficiaries. Trusts can be arranged in many ways and can specify exactly how and when the assets pass to the beneficiaries.
Julius Baer’s three trust companies have existed for decades. Two of them have been serving clients for over 30 years. The youngest trust company in Singapore will turn ten this year. Throughout this time, we have talked to clients from all over the world about setting up structures for their families.
But how to best set up a trust? And what are the things to be aware of? Learn from seven common mistakes made by families around the globe:
1. Mixing up trusts with bank accounts
A well-planned trust sets significant funds aside for the longer term to ensure that there is capital for the long-term plans of the family, which can complement any funds held personally by the settlor. One advantage of a trust is the earmarking of these assets for the next generation, and an element of distancing between the settlor and those assets.
In the case of a future legal attack on the validity of a trust, the behaviour will be considered as well as the formal terms of the trust deed. It is all the more important, then, to ensure that the settlor has kept back funds to meet his or her likely future cost of living. It would be counterintuitive to set up a trust for the long-term and then start withdrawing funds to cover living expenses. Some might consider this equivalent to treating the trust like a personal bank account, and reduce the protections accordingly.
If funds need to be drawn from the trust, infrequent larger distributions or revocations may be more prudent than regular smaller sums.
2. Creating rigid arrangements
Imagine a situation where a family member is in an overseas hospital and needs urgent medical attention. The hospital won’t operate before receiving a deposit for their fees. The trustees are approached to finance this, as the best and more appropriate source of a large payment for a family member, but the person whose consent is needed can’t be reached. The trustee can’t transfer money without breaching the trust. Suddenly a restrictive approach can be a real problem for the family.
Keeping arrangements simple and flexible, and trusting the trustee to execute their role correctly, is often a better solution in the long run. Trustees are already subject to well-established obligations to act in the best interests of the beneficiaries and are subject to extensive regulation.
When setting up the trust, also make sure that a suitable ‘Letter of Wishes’ is agreed on with all relevant stakeholders in advance.
3. Determining pay out schemes – and not informing family members
Setting up a trust can be an important step in making sure that long-term arrangements are made for family members. However, equally important is talking to the family and ensuring they are aware of, and prepared for, the way the settlor wants the trust to operate.
Most families have a strong work ethic, and want their children to make something of themselves. This is laudable, and the trustees can support this by either income matching as an incentive, or ensuring that relatively modest sums are available to meet important basic requirements for the next generation. However, these should not be so generous that the children are given more money than is healthy for their development.
Every family has their own vision, but it must be shared with the whole family to avoid future conflicts arising. It can be difficult for a trustee, faced with limiting guidance from the settlor in the letter of wishes, when a beneficiary is surprised that the trustee can’t pay out more funds outright. Preparing family members as early as possible and getting them on board helps build a healthier and more sustainable relationship with the trustees and the next generation.
4. Building silos between trustees
Say you have a factory in one country, a holiday home in the other, financial assets at various banks and private equity investments elsewhere. Can you squeeze all those assets into the same structure? Should you?
Different trustees may have assets they feel more comfortable with managing, depending on their expertise, size, systems, location and risk appetite. Whilst it might seem appealing to hold all your assets in one structure, for risk or tax reasons it may be inadvisable. Even if you prefer different trustees for different asset classes, you may wish to have a common thread to ensure the trustees coordinate with each other. Otherwise you may reach a situation where a beneficiary approaches both sets of trustees for a distribution and they both say yes without realising the other is doing the same.
Most parents will be familiar with the scenario where a child asks both parents the same question in the hope that one of them will say yes, and never realise the other said no. One way to address this, at least in the trust context, is by having protectors in place for both trusts that should be consulted before making any significant steps. Another is to authorise the sets of trustees to talk to each other and coordinate.
Such arrangements can either be formalised in the trust deed (which may reduce flexibility, if set out in too much detail) or a uniform letter of wishes applicable to all trustees of all family trusts. Alternatively, trustees should be involved in a family constitution or agreement, if one exists.
5. Forgetting to appoint ‘backup beneficiaries’
No one likes to think about the death of loved ones, but, in order to make the most of what a trust has to offer, it pays to be a pessimist for a moment. For example, in an ideal world, you want the trust to be for you and your children, or a cousin. Beyond this, you may not have given it much thought.
Imagine, for these purposes, that everything that can go wrong will go wrong. You and the other beneficiaries of the trust are all in the wrong place at the wrong time and tragedy strikes. The only beneficiaries of the trust have died and the trustee now holds significant wealth and doesn’t know what to do with it…
Maybe there is a sibling, parent, long-lost cousin, or a favourite charity that could be included as a beneficiary or a ‘backup’ beneficiary in case things don’t go the way you planned. These parties can either be added as beneficiaries at the outset (grandchildren and siblings may be suitable for this, depending on the long-term objectives of the trust) or they could be listed in a letter of wishes, which can assist a trustee with power to add beneficiaries.
If you have charities in mind, the more information you can give your trustees about your priorities, the closer they can replicate your wishes. For example, if environmental charities rescuing sea life, or preserving water are important to you, or if a particular school or university holds a special place in your heart, it is helpful to point the trustee in the right direction. Likewise, if one charity should receive the whole trust fund or if you would rather the trustees spread the funds between various causes, this is all essential to know. That way, your trustees know how best to honour your wishes in a meaningful way.
6. Overlooking hidden fees
Everybody loves a bargain, but in their enthusiasm to find a low trustee fee, families sometimes overlook other chargeable fees. Consider whether the trustee you have in mind charges additional fees on top of the annual fee that has been proposed. Common examples include ‘time spent fees’, FATCA/CRS filing fees, ‘infrastructure charges’, accounting fees and transaction fees. These can often add up to several thousands of dollars a year, and are often a surprise for client who had not considered these charges.
7. Not planning holistically
Trusts are traditionally a powerful estate planning tool that can ensure assets are immediately available for the next generation without the delays and complications of a formal probate procedure.
Holistic planning is important. It may be tempting to just solve an immediate problem (“I need a trust for my investments because a friend of mine has one”) and put the rest of the planning on the back burner. Or, a trust might be the last element of an estate planning puzzle to solve, in which case, well done!
Thinking about setting up a trust is a good opportunity to consider the plans made for other assets and when they should pass to a spouse or the next generation.