Diana Clement: Shell trusts good protection for bequests

Bequeathing assets to your offspring is the most natural thing in the world for a good chunk of the population.

But without proper planning of this generational wealth transfer you could be handing your hard-earned assets straight to your son or daughter's good-for-nothing existing or future partner - or even business creditors.

That's why increasing numbers of people are opting to set up inheritance trusts. These are shell trusts with no assets to which you bequeath your assets on death.

"Using a shell trust - some call it a receptacle trust - is a way of avoiding doing a trust in the beneficiary's lifetime," says trust expert Bill Patterson, of Patterson Hopkins Barristers & Solicitors

"[That's] usually because they can't make up their mind about which of their own assets they want to put in trust ... and to avoid having a long will."

The idea is that instead of bequeathing the money to the children or other beneficiaries directly, you pass it to a trust which, with a correctly drafted deed, should protect the assets from acquisitive third parties.

There are plenty of scenarios aside from the dodgy partner where assets bequeathed directly to a beneficiary could be lost. You're not to know, for example, that when you die your beneficiary will be under investigation by the Inland Revenue Department, which would love to get its tentacles around your bequest.

Bequeathing to a trust can also take the pressure off your offspring whose spouses or partners may want the inheritance spent on paying the mortgage off, starting a business, or buying a boat or bach, says Nicky Reid, business development manager at Perpetual Trust.

Assets inherited are automatically separate property. But it only requires a small amount of the inheritance to be used for joint purposes before it becomes subject to the Property (Relationships) Act.

"You can imagine how difficult it might be if you receive an inheritance," says Reid. "Your partner will know that your parent has passed away and might think 'we can use this as collateral for a business deal'.

"You can protect the inheritance from your partner, but you are going to have to make a conscious choice to do so."

Inheritance trusts are quite flexible vehicles. Other people such as aunts and uncles or grandparents can also either bequeath or gift money to them, although gifting limits apply to the latter.

A trust might not be the right thing for people who are getting older.

"Inheritance trusts have found a niche for people who have accumulated reasonably substantial amounts of assets and are in a position where gifting $27,000 a year, or $54,000 for a couple, won't make much of a dent. But they still want to protect their assets for their children and grandchildren," says Reid.

For some people it can be a disadvantage to transfer the home to a family trust during their lifetimes. The family home is exempt from residential care financial thresholds, but a home transferred to a family trust where gifting hasn't been completed, isn't.

If the children already have their own trusts in place in their own name, it's possible to bequeath assets to those trusts. But if it's a joint trust for your son/daughter and their spouse, then you may want to think twice, says Reid, because the assets "in essence" become matrimonial property if both partners are beneficiaries.

Another option for bequeathing money safely to children is a testamentary trust under a will. These are, however, quite rudimentary compared with inheritance trusts.

For example, says Reid, an inheritance trust with full discretionary powers may be able to go guarantor for a beneficiary who needs to borrow money, whereas that may not be done easily with a testamentary trust.

For a testamentary trust to have the powers and flexibility of an inheritance trust the will may need to be very long. "You don't want a will to be that long," says Reid.

Parents can't 100 per cent control how the trust is managed after their death. But they can write a memorandum on the subject or attach a letter of wishes giving direction to the trustees about how they would like money managed after they are no longer alive. These letters can be handwritten and updated from time to time if necessary.

They become important when there is a potential beneficiary with drug, gambling or other issues. In those circumstances you could direct the trustee to take certain actions such as consulting with a third party or sibling before they respond to requests for larger sums of money.

This might help prevent a P-addict from getting his or her hands on money, which could be misused.

Letters of wishes and memoranda are not legally binding. But if you have independent trustees it's unlikely they wouldn't "incorporate" the parent's wishes, says Reid.

Beneficiaries can ask for distribution of a trust to be brought forward from the 80-year statutory limit or any limit set by the settler.

Trusts of any type come with traps for the unwary. With inheritance trusts, for example, if you make the beneficiaries trustees you are at risk of the exercise becoming pointless. That's because a partner could pressure the beneficiary to use powers as a trustee to access the capital.

Also if the trust was under attack by creditors or other parties, there is case law supporting the view it can be challenged if you have the power to add and remove beneficiaries and trustees and to veto, says Reid.

Your wishes as a settler can be defeated if you choose to cut out members of the family financially. There is legislation that enables people to make claims against a deceased person's estate, says Patterson. That includes the Property (Relationships) Act and the Family Protection Act. The latter permits spouses, partners, children, grandchildren and, in limited cases, parents or step-children to make claims on a breach of moral duty to provide for them under the will.

Patterson cites one case he won where two adult children successfully intercepted their share of an estate before it reached the trust - because they argued there was a moral duty by the parent under the Family Protection Act to provide for them.

He adds that the Law Reform (Testamentary Promises) Act 1949 allows anyone to make a claim if they can prove there was a promise to provide for them in the will in return for services provided. "It is sometimes remarkably easy for claimants to make allegations which are hard to refute," he says.

Another potential issue, says Patterson, is that an inheritance trust does not give any asset protection to the will-maker, only to the recipient. "The only way for the upstream players to get asset protection for both himself or herself and for the downstream recipients is putting their assets in trust during their lifetime."

It's a common misconception that if you have a trust in place there is no need for a will. That's not the case, says Reid. "You can't bequeath without a will."

What's more, a will extinguishes gifting on a parent's assets, so they can pass straight into the trust and the beneficiaries do not need to gift that money over a period of time - which means, among other things, that it doesn't become part of the equation for residential care subsidy of the beneficiaries, who won't always be young themselves.

Once set up, inheritance trusts cost little to administer during your lifetime - unlike family trusts. It is only when the assets are transferred to the inheritance trust that the costs kick in. A typical inheritance trust costs $950 plus GST to establish, says Reid, although each case is different.