Trusts are essential to estate planning because they allow wealth owners to pass assets to beneficiaries without worrying about probate court proceedings. They also provide flexibility for beneficiaries regarding how they receive wealth.
Without estate planning vehicles, the transfer of wealth occurs directly with a change in ownership. Probate procedures can be complex, costly, lengthy, and often public.
Shared ownership of specific assets may create issues and tensions among beneficiaries, putting family wealth at risk.
Furthermore, wealth succession without estate planning vehicles may trigger a substantial tax burden and will not guarantee multigenerational wealth preservation and transfer.
This blog post will assess estate planning trusts' benefits and use cases.
What is an estate planning trust?
There's no unified definition of trusts due to their flexibility and variety. Although there appears to be an overarching basic model, it comes with myriad variations depending on the jurisdiction.
The European Court of Justice, in a case about the recognition of trusts, provides the following comprehensive description of trusts:
"In common law jurisdictions, the concept of a 'trust' involves a triangular transaction, whereby the creator of the trust ('the settlor') transfers assets to a person, the trustee, who is required to deal with those assets in accordance with the instrument creating the trust ('the trust instrument') for the benefit of a third person, the beneficiary.
Trusts established for the benefit of specific individuals are sometimes called settlements.
The distinguishing feature of a trust is that ownership of the assets comprised in the trust is divided into legal ownership and economic ownership, the former held by the trustee, the latter held by the beneficiary.
Although a trust is legally recognised and has legal effects, it has no separate legal personality and must act through the intermediary of its trustee.
Assets comprised in the trust are not part of the property of the trustee. The trustee must deal with those assets as separate property, distinct from his own property.
The fundamental duty of the trustee is to comply with the conditions and obligations stipulated in the trust instrument and by the law in general."
An estate planning trust holds assets over generations or transfers them to the following generations. Thus, the trust replaces or complements traditional succession instruments such as wills or inheritance agreements.
This can achieve the sustainable and long-lasting preservation of family wealth, with family members benefiting from the trust assets.
Estate planning trusts can be created for many reasons, such as avoiding probate court proceedings, protecting assets from creditors, and ensuring that certain family members receive specific items.
The parties to a trust
The settlor is the person who creates the trust. She transfers assets to the trustee, who manages them according to her intentions.
Once the trust is established, the settlor usually no longer has a legal relationship with the trustee and the beneficiaries.
Furthermore, she has no function in the administration of the trust but may reserve certain rights in the trust instrument.
The settlor may also provide for herself as a beneficiary of the trust.
The trustee administers assets transferred to it by the settlor for the benefit of the beneficiaries.
The trustee holds the trust assets separately from its estate and manages the trust assets following the settlor's intention.
It has to comply with the trust instrument and legal requirements. The trust itself has no legal personality and is represented by the trustee in its function as a trustee.
A trustee may be a natural person or a legal entity, and several persons may cooperate as co-trustees.
The beneficiary is the person for whose benefit the trustee manages the trust assets. Both natural and legal persons can be beneficiaries.
Often, groups of persons are designated beneficiaries. Their beneficiary status may also be subject to conditions such as age.
A protector oversees the trustee's activities and may have a consultation, instruction, and veto power. Furthermore, a protector may also be granted the right to dismiss the trustee and appoint a new one.
Since the settlor usually does not influence the administration of the trust after its establishment, the protector can exercise a vital control function and safeguard the interests of the settlor and the beneficiaries vis-à-vis the trustee.
Types of trusts
Trusts can be created during the settlor's lifetime or with a testamentary disposition. Other essential differences concern the position of the beneficiaries and the settlor's power of influence after the trust has been created.
Discretionary trusts and fixed interest trust
The difference between these types of trusts lies in the beneficiary's position.
In the discretionary trust, the trustee has discretion regarding the distributions to the beneficiaries.
The discretion includes to whom, when and to what extent assets are distributed to beneficiaries. Thus, the beneficiaries have no fixed claim against the trustee for distributions they could enforce in court.
However, they have a claim to accounting and other information to monitor the trustee's activities. The trustee cannot act arbitrarily but must comply with the requirements of the trust instrument.
In a fixed interest trust, on the other hand, the trustee has no discretion, and the beneficiaries' rights are set. In this case, the interests and claims of the beneficiaries are predetermined.
The trustee must make distributions following the beneficiary provisions outlined in the trust instrument without exercising discretion. The beneficiary entitlement may be on capital or income, or both.
Revocable and irrevocable trusts
In the case of a revocable trust, the settlor reserves the right to revoke the trust and recover the trust assets. With a revocable trust, there is no ultimate depletion of wealth during the settlor's lifetime.
As a general rule, distributions already made are not reversed upon revocation. Upon the death of the settlor, the trust becomes irrevocable.
With an irrevocable trust, the settlor already forgoes the possibility of revoking the trust when it is created.
Thus, the settlor definitively gives up the right to the trust assets.
This completes the separation of the trust assets from the other assets of the settlor, and the trust assets are no longer attributed to the settlor.
In practice, the above concepts vary depending on the trust jurisdiction.
The type of trust ideal for estate planning depends on individual circumstances and goals for succession.
Why should you create one?
A trust preserves family wealth and ensures a regulated and straightforward succession. Various reasons can lead to the decision to set up a trust.
For example, an inexperienced and irresponsible family member can endanger family wealth. With a trust, an individual solution can be developed to protect wealth and the beneficiary.
In addition to the regulated succession, entrepreneurial families will also appreciate the asset protection possibilities of trusts. Entrepreneurial risks can be managed by separating assets, and creditors' claims can be limited.
Furthermore, contrary to a will with a trust, you can steer when beneficiaries should benefit from assets and implement a setup in line with specific family requirements.
Trusts and inheritance laws
Estate planning with trusts reaches limits when inheritance laws conflict with the trust's provisions. This manifests, in particular, the differences between civil and common law.
Common law relies on judicial precedents to solve court cases, even if they have statutes. Frequently, it provides freedom of testamentary disposition, which means you can pass on your wealth to anyone.
It may only be limited by mandatory family protection, depending on financial need.
Civil law is based on written statutes or legal codes, which are updated continuously, and case law is a secondary source.
Typically, it comes with a restriction of the freedom of testamentary disposition due to forced heirship rules.
Let us take Swiss law as an example. The testator can only freely dispose of the so-called available quota through a disposition upon death.
A part of the estate is preserved for beneficiaries entitled to a compulsory portion, such as descendants or spouses. In addition, the compulsory portion must be unencumbered and not subject to conditions and obligations.
In certain situations, a beneficiary of a compulsory portion may be disinherited. But here, too, the law sets narrow limits.
The area of tension between trusts and the right to a compulsory portion
For testamentary dispositions with which a testator exceeds her power of disposition and violates compulsory portions, Swiss law allows challenging them to restore the permitted degree of disposition.
The object of contestation is the testamentary disposition by which assets were transferred to the trustee.
If the trust was already established during the lifetime of the wealth owner, the assets do not form part of the testator's estate but can still be contested under certain circumstances.
Without wishing to go into technical details, like with dispositions upon death, gifts, and donations, i.e., all types of asset disposals without consideration, which reduce wealth or prevent its increase, are subject to claw-back claims.
While most claw-back claim scenarios are between heirs, gifts that the decedent was free to revoke or that she directed during the five years preceding his death are also contestable.
If the creation of a trust is economically equivalent to a gift, revocable trusts are likely to fall under the concept of a revocable gift, and irrevocable trusts are likely to be treated as an irrevocable gift.
However, this does not mean that every irrevocable trust created at least five years before the settlor's death is safe.
This is because the alienation of wealth made to circumvent the restriction on the disposition is also subject to claw-back claims.
From a Swiss perspective, the right to a compulsory portion prevails over a trust. Of course, the question of enforceability arises in the case of foreign trusts.
Nevertheless, the statutory provisions must be considered to obtain certainty and avoid lawsuits between heirs.
How to prevent trust disputes and litigation
Here you can already solve many issues with the right estate planning approach.
You provide the fundamentals for a solid estate planning framework with a comprehensive inventory of all assets, clarity about ownership structures, and an assessment of applicable law, jurisdiction, and relevant procedures.
Where possible, you should consider lifetime giving and inheritance contracts to determine wealth distribution and transfer with your beneficiaries during your lifetime.
You can combine estate planning vehicles to diversify risks for everything that needs to be solved after your lifetime.
If you have implemented a family governance framework, alternative dispute resolution between family members could prevent litigation.
Regular reviews will ensure that your estate planning setup matches the current circumstances.
Avoiding family conflicts
The number one threat to family wealth is the conflict between family members.
Sharing the intention of a trust will inform family members and ensure they buy into wealth preservation.
Communicating and avoiding surprises contributes to positive family dynamics where everyone knows their entitlements and responsibilities.
Clear expectations prevent disputes, and wealth can be preserved in the long run with beneficiaries' involvement.
Thus, involving your family in the estate planning process is probably the most effective risk mitigation measure.
Risk mitigation for estate planning trusts
In addition to the above, you can provide specific risk mitigation at a trust level.
For instance, aligning the trustee's jurisdiction and applicable law with the assets' custody location will avoid forum shopping of unsatisfied heirs and beneficiaries and ensure a unified application of the relevant regulations.
Beneficiaries attacking the trust could be punished with so-called no-contest clauses that eliminate or reduce their beneficiary status in such events.
Some jurisdictions, such as Liechtenstein, allow alternative dispute resolution provisions in the trust instrument.
Combining trusts with other estate planning vehicles
The combination of trusts with other estate planning vehicles can significantly enhance your estate planning arrangement.
Life insurance policies fit into various trust schemes. Their benefit is reducing complexity in holding wealth and complying with regulatory requirements such as the international exchange of tax information.
Since life insurance is widely recognized, it may enable tax deferrals or preferential treatments.
Corporations can also help consolidate assets under a trust rather than holding them directly. In particular, they may offer additional flexibility to manage bankable assets.
They also allow the segregation of assets to mitigate risks triggered by business activities.
Foundations are legal entities without members, shareholders, or stakeholders established to fulfill a specific purpose for the benefit of designated beneficiaries.
Since they are a typical civil law concept for such jurisdictions, they may be better understood and recognized than a trust.
Still, you could create a foundation and trust for a specific group of beneficiaries depending on their country of residence.
Combining estate planning vehicles enables diversification. Just consider that the attack of creditors and heirs can paralyze a single estate planning tool, while a diversified setup will still serve beneficiaries' needs.
To conclude on estate planning trusts
Estate planning trusts allow flexible arrangements to hold and distribute wealth after the settlor's lifetime. Still, they work best if they are established with simplicity and straightforward execution in mind.
A combination of estate planning vehicles enables diversification and risk mitigation.
There is no single tool that addresses all needs, and also, in this context, simple arrangements are understood after the settlor's lifetime.
Comprehensive estate planning considers asset protection, estate tax exposures, and financial planning.
Regular stress testing considers what-ifs and changes in circumstances. Finally, involving your family in the estate planning process and starting early enough will lead to robust results.