Understand a Trust in Just 5 Minutes
The moment you start to look into how to protect your assets and safeguard your income in a long term, sustainable way, you’ll encounter trusts. They are everywhere you look, people will assume you understand the basics, and many articles won’t stop to explain the fundamentals. The problem with this approach is that if you want to make the smart decisions that will secure your financial future, there’s no substitute for a quick refresher on the foundations.
What is a trust?
A trust is an agreed relationship between two or more parties. It is not a physical or legal entity like a person or business, it is an agreement that sets out how all the relevant parties will behave with respect to one another.
What can’t a trust do?
It’s just as useful to know what a trust can’t do, as well as what it can do. Trusts cannot own assets, be represented in a court of law, or be bought and sold like stocks and shares. They are simply no more than a legal term for a specific type of relationship.
What is the purpose of a trust?
High net worth individuals want to ensure that their assets pass down the generations with the minimum of friction. This is only possible on a longterm basis when the relationships and expected actions of all those involved are set out clearly in writing. This is what a trust does, and they’re used all over the world.
Trusts begin when an individual agrees to hold or look after a specific list of assets so that someone else will benefit. Your own personal savings are not a trust, but looking after someone’s trust fund would require a trust. In short, it is a legal mechanism by which someone does you a highly specific and detailed favor in relationship to a set list of assets.
The person running the trust cannot simply sell what it contains because the beneficiary of the trust will expect to be able to access it in its entirety, or in part, at some later point in time. Trusts can however be transferred to one or more people under a preset list of agreed conditions. These could an increase in size or scope of the trust, a change in circumstances or living conditions, or death and serious illness. The purpose of trust law is then to codify these scenarios so that everyone knows precisely where they stand in any eventuality.
How might you use a trust?
You may think that such an arrangement is only useful in terms of saving time and paperwork, but trust law is a very rich and diverse topic. Many high net worth individuals decide to place their assets in the hands of a trust so that they can be better shielded from a whole host of outside influences. This could be to minimize exposure to tax through proper wealth planning, or even to help move assets globally when individuals are moving between countries of residence.
Wealthy families will typically use trusts to shield their collective wealth from individual misfortune. For example, if virtually the entire wealth of a large family were in the hands of one member of the family who then sadly and unexpectedly passed away, this could cause significant upheaval for the structure of the family and its finances. If on the other hand the money had already been placed in a trust, there would be a clear direction of travel for the family’s wealth as a whole, and for the actions of each individual family member. When you consider that this would have to be carried out during the grieving period, you start to see just what a useful instrument a trust can be in more ways than one.
Can a trust be insolvent?
Companies and businesses can be insolvent and cease to trade, but trusts are a little different. Generally speaking an insolvent trustee will no longer want to be in charge of managing and distributing the trust. They will want to step aside and allow someone else to take up the mantle, and the way in which this is done is well established. Trust law builds in such a mechanism into the structure of each trust, ensuring that when the torch is passed the underlying assets and core relationships of the trust are unchanged. This is one of the principle reasons why wealthy families use trusts to maximize the chances of their full wealth being passed down the generations without friction, delay or hinderance.
How do trusts partner with businesses?
This is a question that is of particular importance to those looking to shield a large family business so that it is not broken up and sold off. Running a family business can be a political and highly nuanced affair, requiring the delicate management of many personal / business relationships which can be trying at the best of times. It can also result in a number ofad hoc arrangements which on the surface work perfectly well, but in practice quickly become exposed when the principal shareholder or leader of the business either steps back or passes away unexpectedly. In these such situations it can be drawn out, expensive and time-consuming to realign the business structure if a trust is not in place.
For this very reason trusts are a tried and trusted mechanism by which a family can maintain a controlling interest in their business across decades. Even if the majority ofthe day-to-day operations are only overseen by one or two specific family members, the shareholding can be legally secured by means of a trust. This allows the family as a whole to maintain ownership of the business in way that is safe and secure for years to come.
These types of arrangements become particularly important when the founding shareholder is suddenly and unexpectedly unable to run and manage the business to full capacity. Accidents are a common reason why this may be the case, and are a primary motivation for structuring a trust to safeguard the family business as a whole.
Are trusts socially responsible?
You only have to look at the news to see stories of now high net worth individuals and wealthy families are negatively perceived by certain sections of the political spectrum. While there will always be different swathes of opinion regarding the redistribution of assets and income, it is still right to ask whether forming a trust is a socially responsible thing to do for the beneficiaries of the trust themselves.
Inheriting untold wealth and seemingly limitless assets at a young age may sound highly beneficial, but the real world shows us that it actually serves as a burden that can be too heavy to carry for many. Young people who do not yet have the maturity or skills to manage such wealth can quickly become exposed to peer pressure, unwanted outside influence and the mental health issues which can result from the lack of direction or purpose caused by overly easy access to significant wealth.
When you start to think about the formation of a trust from the point of view of a parent looking to safeguard the wellbeing of the next generation, you start to look at far more than just the numbers. Preventing access to the contents of a trust in their entirety until the beneficiary is of mature age and sufficient understanding to use it in a meaningful and productive way is highly important; as are a number of pressing practical matters which we will address by asking one last question…
Why do trusts offer longterm stability?
No one knows for sure what the future will hold, this much is obvious. As well as markets going up and down and industries coming and going, there are a number of far less abstract factors which deserve ample consideration.
The simple question of where the next generation will choose to live, the professions they will go into and the people they will marry all need to be asked when it’s time to address the issue of wealth management. A trust then becomes a highly useful and flexible tool in those years in which most of these questions are still a long way away from being satisfactorily answered. In short, a trust allows you to take a pragmatic, structured approach to managing and passing down wealth in a way which is tried and tested in accordance with a well developed set of laws.
What’s the take home point?
Trusts allow wealthy families to benefit from the fruits of the labor of the founder shareholder in a family business, or the primary wealth generator. This means that when that person retires, passes away, or is no longer able to work for any other reason, their affairs will be in order.
The way in which the assets contained within the trust are distributed, how they are to be managed in the future, and who has access to them will all be laid out by the structure of the trust. This is very well developed set of laws based on English Common Law and is an approach used the world over.
In a world in which nothing is certain, trusts provide a legal framework within which to protect wealth and assets.
