Money matters: Beware of the pitfalls when forming a trust

By MARY HOLM

Q: A couple of years ago I was looking at setting up a family trust when I read about them. Among other things it said: "People might also be tempted to use a family trust to reduce the impact of means testing or Government duties on their old age, or for income tax purposes."

The writer concluded: "Any gift of assets to your family, and any disposition of assets to a trust, may be ignored by the Director-General of Social Welfare when it comes to assessing your entitlement to Social Welfare benefits."

I have heard many speakers encouraging the setting up of trusts, but none has ever mentioned this "downside." Is this omission on purpose?

I know the article was printed in 1998, but it did stop me from forming a trust. Did I make the right decision, or is the reference to the possibility of the trust being ignored by the Director-General incorrect?


A: It's correct. And the point probably isn't made too noisily by speakers who make a buck out of setting up trusts for people. Funny that.

When a person transfers assets into a family trust, he or she usually does it by lending the trust the money to buy the assets.

Almost always, the loan is repayable on demand, says Doug Craig, national manager of legal services at the Department of Work and Income, which administers the relevant act (the Social Security Act 1964).

"Of course, usually no demand for repayment is ever made, and in fact the lenders setting up the trust are more interested in gifting the debt away as quickly as possible," he says.

Under the tax law, you can gift up to $27,000 a year without paying any gift duty. But, says Craig, this has nothing to do with his department's policy on gifting.

The department lets you gift just $5000 a year. If you've given more than that, "usually this would mean that the income of any applicant for a benefit would be adjusted upwards to reflect the income or asset forgone," he says.

There's a similar rule for rest home subsidies. If you gifted $27,000 three years ago, and then applied for a subsidy, the department would consider $12,000 of that as still being yours.

Work and Income has a policy of ignoring gifts made more than five years before you apply for the subsidy, but there is not actually any legal time limit.

"The department reserves the right to look at any individual cases going back more than five years where there has been significant gifting," says Craig. "What is significant will depend on the facts of each case."

He also notes that it's not relevant that you set up a family trust for reasons that had nothing to do with benefits or subsidies.

"The High Court and the Social Security Appeal Authority have both held that, while people are perfectly entitled to order their affairs as they see fit, and that there are any number of legitimate reasons for doing so - for example, protection of family from creditors, or preservation of interests of children from previous marriages - such arrangements are nevertheless caught by the provisions of the act."

Overall, he adds, "unless a trust has been in operation for a considerable number of years, it will have very little ability to assist a person in getting a benefit or a subsidy or a higher rate of either."

Bell Gully partner Richard Taylor, a trust expert, basically agrees with Craig.

"I always try to ascertain why people want to set up a trust," he says.

"If the primary motive is to try to qualify for a residential care subsidy, I discourage them from proceeding, particularly if they are elderly people likely to perhaps need rest-home care in the near future.

"But if qualifying for a residential care subsidy is merely one of their purposes, and if they have other good reasons, I say 'Go ahead and set it up'."

Taylor emphasises Craig's point, that the usual five-year "lookback" for those applying for the subsidy is only policy.

"They can change policy very easily," says Taylor.

"In any event, the key to qualifying for a residential care subsidy is to have taken appropriate steps many years in advance."

Underlying all of this, says Work and Income's Craig, is the idea that "normally people must look to their own resources before they can access Social Security benefits.

"The practical result of this is that people are limited in what they can do with those resources if they subsequently wish to seek the support of the taxpayer."

To which I add, "Fair enough."

Q: In last Saturday's column, you stated that " ... the possibility of being taxed on gains doesn't seem to put people off investing in shares." Are you really sure of this?

I do know the murky capital-gains taxation laws have indeed affected my investment decisions.

As well, I've heard other investor/traders say that taxation uncertainty affects their investment strategies too.

Now I don't mind paying capital gains taxes. But I like to know what the taxation rules are before entering an investment and that the rules are applied equally. In New Zealand they are not.

I firmly believe that this taxation uncertainty has been and is a disincentive to investing in our country's companies. Which is a real pity. Thanks for listening.


A: It's a pleasure. Really, it is. That's because I heartily agree with you.

You were quite right to pull me up on my ill-thought-out comment that our tax system doesn't put people off buying and selling shares.

Obviously it doesn't stop some people from trading. But who knows how many others hold back?

I think the New Zealand capital gains situation is horribly confusing, and that we would be better off taxing all capital gains.

I even think - although many politicians would baulk at this - that we should tax gains on people's homes.

Making homes an exception, as is the case in some countries, distorts people's decisions. They put more money into their houses and less into other investments than they otherwise would. This leaves both individuals and the economy worse off.

If capital gains were uniformly taxed, I would of course expect an offsetting drop in income tax.

The result: the Government would take less of the money that people earn by working, and more of the money people get by sitting around and being lucky.

Who but the particularly lucky ones would argue with that?

* Mary Holm is a freelance journalist and author of the newly published Investing Made Simple. Send questions for her to Money Matters, Business Herald, PO Box 32, Auckland; or e-mail: maryh@journalist.com. Letters should not exceed 200 words. We won't publish your name, but please provide it and a phone number (preferably daytime) in case we need more information. Mary cannot answer all questions, correspond directly with readers, or give financial advice outside the column.