Early planning for wealth protection, preservation, and succession for the next generation is crucial. The establishment of a trust is one method that has provided many people with a great sense of relief regarding their wealth planning during uncertain times. Family Trusts are especially critical for High Net Worth (HNW) families, individuals, and business owners. The need for more sophisticated wealth management solutions in Hong Kong and the larger Asia area has increased as people become better-off and financially knowledgeable. While the wealthiest generation since World War II, the baby boomers, have reached or approached their retirement age, there is a clear demand for wealth protection, preservation, and transition.
What is a Trust?
A Trust is a wealth management tool that allows the creator (the settlor or grantor) to transfer legal title of assets to another party, the trustee to hold the assets for the benefit of the beneficiaries. Trusts should be used in conjunction with a Will and may be revocable or irrevocable. They are more flexible than Wills because they allow the settlor to express his/her wishes to the Trustee as to how the Trust assets should be applied for the benefit of the beneficiaries while they are still living. Trusts have a lot of advantages when it comes to asset management and protection. Some types of Trusts enable the settlor or another appointed person(s) (rather than the Trustee) to manage the investment of the Trust assets. Trusts can also protect the Trust assets against attack by creditors of the settlor, both during and after the lifetime of the settlor, whereas a Will does not provide such protection.
A trust is generally a legal arrangement amongst three parties: the settlor, the trustee(s), and the beneficiary/beneficiaries, in which the settlor entrusts the trustee(s) with the legal ownership of his/her assets for the benefit of one or more beneficiaries.
Parties of the Trust
- The Settlor: The individual who establishes the trust and subsequently transfers ownership of assets to the trustee to carry out the objectives of the trust.
- Trustee: The person entrusted by the settlor with carrying out the trust's objectives.
- Beneficiary: The person(s) who benefits from the trust property. It is possible to designate several beneficiaries, as well as alternate beneficiaries, or a general class of beneficiaries (such as the settlor’s children).
Common Types of Trusts
Private Family Trusts: Setting up a private family trust to manage an individual or family’s wealth has a number of advantages, including increased privacy, asset protection, asset consolidation, succession planning, and more. Private family trusts are typically created to allow a person's assets to be utilized in certain ways both during his or her lifetime and after death, while also avoiding the time-consuming and sometimes costly probate court process. A family is never immune to lawsuits or poor business decisions that put its assets in danger; the trust is a vital legal mechanism for safeguarding the wealth the settlor has worked so hard to accumulate over the years.
Many high-net-worth families choose to set up a private family trust as an effective way to protect and pass on a significant amount of assets to family members, designated individuals, and/or entities (charities, for example). This provides continuity in managing a family’s wealth, and a properly set up trust ensures benefits to family members across generations.
Why Use Private Trusts?
Protection Against Third Parties: Reduce the likelihood of family conflicts and better protect assets from creditors and lawsuits. Consider the following scenario in which a child of the settlor is divorcing. The lawyer of the child’s spouse would try to claim the maximum amount of assets owned by the child as possible as part of the divorce settlement. This can be equal to half of the total assets that the child owns, in many countries. However, if the settlor successfully establishes a trust for the benefit of his child, these assets can be protected against claims by a divorcing spouse of the child if the child is a discretionary beneficiary of the trust.
- Tax Planning: An individual can sometimes minimize his/her tax liability by using a trust. The settlor of a trust can sometimes reduce their tax exposure. However, individuals should always seek professional tax advice before setting up a trust to ensure that the trust does not expose the trust assets, or the settlor and/or the beneficiaries to adverse tax consequences.
- Flexibility: A settlor (who contributes the assets), a trustee (who receives and holds the assets), and a beneficiary or beneficiaries (who receive(s) the benefit of the trust assets) are the three essential parties to a trust.
Certain types of trusts can hold underlying investment, operating or trading companies that allow the settlor and his/her family members to act as directors of, and manage, those companies.
Initial Public Offering (“IPO”) Family Trust
A Pre-IPO or Post-IPO family trust is a trust-structured holding vehicle into which a firm's founders and important shareholders can transfer their considerable holdings of company shares before or after the company goes public.
A Pre-IPO family trust is created in advance of a company’s IPO to hold the company's publicly traded stock. The purpose is to transfer and hold the company shares of individual important shareholders, such as the CEO, chairman, founder, and senior executives into their private family trusts before the company is listed. It has a long list of advantages, including:
- Succession Planning and Protection of Assets: AA settlor can use the succession planning aspects of IPO trusts, similar to ordinary trusts, to ensure that his/her family benefit from the assets, (his/her shares).. The trust safeguards the settlor’s personal assets while allowing him/her to pass on the benefits to his/her heirs. Additionally, it protects the trust assets against legal claims by third parties against the settlor or his/her family members. It also helps to avoid probate and preserve privacy, regardless of the number of family members or generational changes.
- Risk Mitigation: The Trust can help mitigate the impact of pending lawsuits and unexpected events, such as sudden death or incapacitation of the founders.
- Tax Planning: The IPO Trust can sometimes aid in more efficient tax planning for a company’s founders before it is listed. It provides an opportunity for the founders to possibly mitigate their tax liabilities.
- Ownership Segregation: Placing the shares in a trust can prevent segregation of the company's shares (e.g. if the shares are held by individual family members). This keeps the voting rights of the company shares owned by the founder or his family members from being diluted, which is crucial in family-owned businesses.
Employee incentive systems can also be established using trusts to attract, reward, motivate, and retain staff. Employee Share Ownership Plans ("ESOPs"), which are also known as Employee Benefit Trusts ("EBTs") are rapidly being adopted by a variety of businesses, ranging from start-ups to huge corporations. Employees can become owners of their company's stock, promoting the company's long-term growth and sustainability. The company can determine the vesting schedules and/or conditions, awarded to its employees under such schemes.
Engaging a Professional Trust Partner
It may seem complicated to establish a trust or trusts for a family or business. In the long run, knowing that one’s legacy is secure can bring significant peace of mind. As organizations strive to focus on their areas of competence, specialists are attending to tasks such as financial planning, tax planning, and other similar processes. Choosing a professional trust partner with considerable expertise and experience is recommended for customizing the trusts to meet the specific needs of the client. Their role is to advise on the best types of trust structures and jurisdictions, that are customized to meet specific needs of each individual client, assist with all aspects of trust administration,. A professional trust partner can ensure that their client’s assets and investments are protected and preserved for the specific purposes of the client both during his/her lifetime and for his/her future generations.