Wealthy families are often confronted with choices as to how they can hold their wealth. Broadly, the choices are holding these personally and devolving wealth on death, in a holding company held personally, or through fiduciary holding structures, such as a trust or foundation. Why do families choose trusts and foundations to structure their affairs and what advantages and disadvantages do they have to offer? This depends to a significant degree on the family itself, and specifically, where they are located, what assets they own, tax treatment, and the objectives of the family (or decision makers within it).
Quite often, the decision maker for families is vested in the older generation, perhaps a matriarch, a patriarch or both. Their objectives as regards their wealth generally fit under the following categories:
- smooth succession planning, that is, how the family wealth is passed on and how investments are managed; asset protection; tax efficiency; order; and cost (which will be addressed in another article).
Succession Planning
Holding assets personally means assets are held in the personal estate. The problem with holding assets personally and relying on lifetime gifts or a will (assuming such Will does not establish a testamentary trust) is that:
- control is generally lost at the point at which the gift is made or death occurs;
- some jurisdictions have legislation that enables family members or other interested parties to challenge the terms of a Will after death;
- some jurisdictions have forced heirship provisions, which override the terms of a will;
- if assets are held across jurisdictions, several wills complying with different jurisdictions’ requirements may be required to deal with the whole estate;
- incapacity is a real issue where the wealth holder holds assets in their own name and all of a sudden they are not able to deal with them – expensive court applications can be required to resolve this; and
- it can take time from the point of death to bring in the assets and distribute them – this can cause issues where there are dependents reliant on the deceased’s assets.
Holding assets in a trust can address these issues. This is because assets held in trust:
- as to how they are dealt with, are administered in accordance with a trust deed, usually combined with a letter of wishes addressed to the trustee – these two documents can provide a degree of input from the person establishing the trust as to how the assets are administered and distributed, both during the life and after the death of the decision maker. It would be an exaggeration to say this amounts to control from the grave, but in practice, it is perhaps halfway there;
- do not form part of the deceased estate;
- tend to be more difficult to challenge for aggrieved beneficiaries;
- can be established in jurisdictions that contain firewall provisions that may mitigate or eliminate the application of forced heirship provisions;
- can form a consolidator vehicle for all assets, regardless of asset situs;
- incapacity of a beneficiary or original custodian of the family wealth does not affect the operation of the assets, which are administered and controlled by the trustee; and
- if established during life, the death of a settlor should have little impact on the lives of dependents insofar as access to trust resources is concerned.
Asset Protection
There are a variety of threats wealthy families face in the context of asset protection. Perhaps the most common are:
- creditors;
- an aggrieved spouse on divorce – this could be the spouse of the head of the family or a spouse of a child or remoter issue who is not intended to benefit directly from the family’s wealth;
- family infighting, which in part overlaps with succession planning; and
- political risk, particularly in emerging markets.
Protections can be split into two categories: privacy and confidentiality, and traditional asset protection.
As to the first, and whilst there are transparency initiatives, such as public beneficial ownership registers that can cut across this, quite often the family want a level of privacy in respect of their affairs and the wealth they hold. Confidentiality protects families because in order to be able to attack family wealth, one first needs to understand what it is, where it is located, who holds it, and how much there is. In emerging markets, privacy can be a matter of life and death. If wealth is held personally, there are a number of ways one can search for this (think land registries and jurisdictions where a Will or probate documents are public documents). Wealth held in trust tends to be more private because title to the assets is held by the trustee or its nominee and the trustee is also (typically and with some exceptions) bound by a duty of confidence as to (amongst other things) the identity of the beneficiaries.
As to traditional asset protection against creditors and other third parties, assets held in trust (assuming it is irrevocable, discretionary and with no fixed entitlement) are held by the trustee on the terms of the trust, and as such, are not owned outright by any one member of the family. This heightens the bar for anyone wanting to get hold of the assets because they cannot (usually) simply make a claim against the wealth transferor of those who inherit – they must typically challenge the validity of the trust itself (or some aspect of it) or the transfer into the trust of the assets.
Family infighting can be a very destructive path for a family to take, both financially and psychologically. In part related to a succession planning strategy that will attempt to manage expectations, assets held in trust and administered by a professional trustee can act as a means by which family infighting can be reduced or eliminated.
Assets held in trust structures can help mitigate political risk, whether via the means described above or through the protection afforded by, for instance, bilateral investment treaties.
Tax Efficiency
Considerations of taxation are quite broad and usually dependent on the nationality, domicile, and residence of family members, combined with the location or situs of assets. Since this is such a broad and typically complex area of wealth planning, it will not be the focus of this article, however, trusts and foundations can act as good tax planning tools to ensure there is no unnecessary tax leakage, although this is not a one-size-fits-all approach and there are instances where trusts and foundations are inappropriate from a tax perspective.
Order
Having several assets and obligations can be administratively time-consuming. Sometimes it is easier to put your affairs in order by using one flexible container to own them in, such as a trust. A professional trustee (together with a family office) can then take care of the administrative affairs of the assets and succession plan of the family, freeing up the family who want to do other things with their time.
This is a very brief overview of some of the advantages that fiduciary holding structures offer wealthy families, who own assets through trusts and foundations. In reality, each area is deeply technical in a legal sense and can differ depending on the family’s circumstances and location (domicile and even religion), the location of wealth, and the governing law of the trust or foundation selected.