Yesterday I said that I belief you should have enough cashflow and some knowledge before you form a trust. Let’s rephrase: If it is a property or a trust, go for the property. Property will eventually help you to get a trust, not the other way around. If you have the money, you buy the expertise you need to have a trust!
So what are the disadvantages of a trust?
First of all a trust costs money to form. You have to pay lawyers and other admin costs. That is only a problem if your cashflow is under pressure. And once again, I would rather use the money to buy a property if it is an either-or situation. This is a once-off expense.
Secondly a trust costs money to run. You need an accounting officer to do the accounts and to do the annual financial statements. This is a cashflow expense. And don’t forget the banking fees, which is also very high.
The same accounting officer should preferably do the tax returns. That is part of the previous expense.
There are many administrative and legal requirements for trusts. That means you need some knowledge or guidance, which you can acquire or buy via an expert.
Trusts have a high tax rate. The income tax rate is very high as is the capital gains inclusion rate.
All the above are obviously not reasons NOT to have a trust. But it does mean that you need some cashflow and some knowledge. And that is why I think many people invest in trusts when they should not really be doing it (yet).
The benefits of a trusts are the following:
Trusts are excellent estate planning vehicles. Since a trust is a totally separate entity, it owns the assets. So whatever assets belong to the trust does not form part of your estate. (An important fact to remember.) Because the assets do not form part of your estate, your estate does not pay executor’s fees or estate duty on assets in the trust. Death is a capital gains tax event, so at least in a trust you can decide when you want to pay capital gains tax. You control selling, but mostly not death!
You can reduce income tax payable by distributing income to trust beneficiaries who will then pay the income tax.
Trusts offer continuity. In other words, having assets in a trust means that your descendants will benefit from your planning far into the future, perpetually. Because of all the costs of dying, an estate is over time decimated. Not so with a trust, because death does not influence the trust. Also, because the assets are in trust, is does not have to be transferred and divided.
Think of this example. You have a very nice holiday home at the beach and 3 children. They inherit equally. Now they each have 2 children, who inherit equally. Then each grandchild – eventually the shares are so small, it is indivisible, over and above all the cost of transferring it all the time. In a trust, it is not a problem.
Trusts offer protection against creditors and divorce. It offers protection to your children against unscrupulous spouses.
So, all in all, I really like trusts. But I don’t think every investor needs a trust before he can start investing.
What do you think? Do you (dis)agree? Any questions? I feel good today, so I will answer if I can, just post it!
People new to property often ask about trusts: “Do you think I should have a trust?” Now that is almost like asking: “How long is a piece of string?” There is not a one-size-fits-all answer to this question.
So let me give you a few pointers:
It is more important to invest in property than it is to have a trust. We will look at some advantages of trusts just now, but being financially free is more important than having a trust.
You owe it to yourself and your children to be financially free. It is admirable to want to leave a legacy for your children, but is more important to be financially free and not a financial burden on your children than it is to have a trust.
A trust is fine, but it also costs money to set up and to run. It is fine if you can afford it, but from what I said above, I would rather use as much money as possible to acquire as many properties as possible before I have a trust.
Now, I am not against trusts, absolutely not. I am against the idea that EVERYBODY MUST HAVE A TRUST or they cannot invest in property. I see too many people who are so entangled with trusts that they forget about property.
As your property portfolio increases, you will “grow into” a trust. As your portfolio grows, you get wealthier, your cashflow increases and so does your knowledge. In time you will have the money and knowledge to have a trust.
Having said that, let me add this: some people are already earning a lot, they have major assets, they have knowledge and experience, in other words, they can afford a trust, then they should get a trust as soon as possible.
What am I saying? I remember when I was still young and studying, I went with my brother in law (a newly qualified lawyer) to a financial advisor. They advisor asked me what I do and when I said I am a student he was not interested at all. He said I must phone him sometime in the future. By that time I already owned my first investment property! But I can remember that I really felt offended. So in a gentle, non-offending, way I am trying to convey the message that you need some money and financial sophistication before you get involved with trusts. The good news is: start with property, and it comes very quickly.
It is like most things in life: crawl, walk, and run. First things first. Do the right thing for you.
Should you have a trust? I really don’t know, unless you tell me what you do, what you earn, what you have, how you are married (hopefully happily?). You see, the right answer depends on your personal situation.
Tomorrow we look at the pro’s and cons of trusts.