Four steps to preserve your family’s wealth and legacy
The past five years have seen more shifting in the landscape for trusts than in the several decades before. The Trusts Act was introduced and took effect in early 2021. After years of consultation and review, reporting and disclosure requirements for trusts have increased considerably through Inland Revenue, and now the trustee tax rate is to be raised from 33% to 39% on April 1 (excluding charitable trusts) – effectively an 18.2% rate increase.
The rationale is to align this rate with the top personal tax rate of 39% for income above $180,000.
However, unlike the progressive income tax system for individuals, trusts will continue to be subject to a flat tax rate. From the first dollar to the last, all trust income will be taxed at 39%, even where the beneficiaries are low- or middle-income and would otherwise be paying much lower tax rates.
On March 27, the ministers of finance and revenue confirmed the passage of the Taxation (Annual Rates for 2023-24, Multinational Tax and Remedial Matters) Bill by April 1. This encompasses the trustee tax rate changes with at least one exemption, the introduction of a $10,000 de minimis income threshold, which means, Revenue Minister Simon Watts estimates, “only around 13% of trusts in New Zealand are likely to be impacted by the change to the top rate”.
Other recommended exemptions – still to be confirmed – are trusts that are settled for disabled beneficiaries, which will still be taxed at the existing rate of 33%, and immediately distributable estates, which will stay at 33% for up to three years from date of death before the tax rate increases to 39%.
Meanwhile, a proposed tweak to income settings means that any beneficiary income distributed to a close company beneficiary will be taxed at the trust rate of 39% rather than the company rate of 28%. In all other situations the trustee tax rate will be 39%.
Whether or not the minister’s estimate of the percentage of trusts now subject to the higher tax rate is accurate, an estimated 500,000 trusts, countless people, whether trustees or beneficiaries, or both, are affected.
Those providing specialist services to trusts and trustees, including lawyers and accountants, are fielding inquiries from high-income taxpayers about alternative avenues, including a shift to portfolio investment entities, which remain at a maximum tax rate of 28%. This casts doubt on the amount of promised increased revenue from trusts that policymakers cited to justify the changes.
Amid this uncertainty, and the inevitable unintended consequences which always arise from changes of this magnitude, including significant negative effects for the everyday middle- and lower-income Kiwis who have trusts for legitimate and important reasons, there are still solutions and rules that, if applied, can help preserve and grow family wealth for generations to come. Here are four:
Talk within the family – then talk some more
Many of the issues people need help to resolve have arisen because of poor communication or misunderstandings about estate planning within families.
Though estate planning offers a range of options, almost all people want to leave at least some money to their children, or available for their children’s and grandchildren’s benefit, while taking steps to ensure wealth is not avoidably diluted, or wasted by poor financial management.
Take, for example, a couple in their 70s with three adult children. If they bought a large house on a full site in central Auckland in the 1980s, in what is today a well-to-do suburb, the property could be worth $4 million to $5m. Combined with other assets, they may have a net worth of seven to eight figures – so how should they structure an inheritance?
Answering this question demands open conversations between the couple, theirestate planning adviser and their three adult children.
❚ Given that every family is unique and a broad-brush approach is not ideal, what should be considered regarding this family’s long-term needs?
❚ Whether the couple want to grow their wealth beyond their lifetimes, or simply distribute assets for their inheritors to do as they wish.
❚ Whether the three children have equal needs, or perhaps one is much more financially comfortable or has much greater needs than the others.
❚ Whether the family have complications or estrangements that may require a role for an independent executor or trustee to minimise further conflict.
❚ The nature of the wider family structure: whether there are grandchildren, and whether the adult children are married or in long-term partnerships, and whether there are contracting-out agreements to delineate individual property from relationship property.
❚ Whether there is a family business, such as a farm, and one child works in it and is housed on the property, so consideration must be given as to how compensation and benefits are balanced among the children and their respective contributions acknowledged.
❚ Whether a family trust is an appropriate vehicle to hold some or all of the wealth in perpetuity, and make distributions of specified amounts and frequency, as opposed to lump-sum inheritances.
Consider what a family trust has to offer
You may already be a settlor, trustee or a beneficiary of a family trust. You may, in light of the trustee tax changes, be considering whether you want to retain a trust at all.
On that point, experts in the sector have legitimate concerns about knee-jerk decisions by trustees, that in their haste to avoid the 18.2% tax rate increase they risk losing 100% of the protections their trusts were set up to create. This could be disastrous, especially for those whose ability to recover from financial loss is lesser.
In short, family trusts can offer a more structured and sophisticated approach than a straightforward distribution from a will, which can be roughly equivalent to writing a cheque.
And the prospect of beneficiaries being free to use large sums entirely as they want may not be a desirable prospect to the willmaker. Unfortunately, this can be how real wealth disappears by the third generation.
In most scenarios, a well-structured family trust that takes into consideration all the variables is the best way to preserve wealth and ensure the people who matter most to the trust settlor are taken care of in the long term.
Understand how to protect the entitlements of adult children in the event of major life changes
The most important changes regarding family wealth are the birth of children and others marrying into the family.
To protect entitlements of adult children it may be appropriate to seek advice on contracting-out or prenuptial agreements, to ensure there is full disclosure of assets and legal status, including whether one or both parties are named as beneficiaries of a family trust.
This way, in the event of divorce, there will already be a plan for distribution of relationship property and knowledge of what it and isn’t included.
Leave a philanthropic legacy
New Zealanders are extremely generous according to global rankings, but most of us have not formalised our giving by establishing vehicles that can support our favoured causes beyond our lifetimes.
Those who choose to do so in a low-key way are often referred to as ‘everyday’ philanthropists – people who, once they’ve ensured their loved ones are taken care of, turn their minds to the long-term support of what matters to them outside the family.
Structures such as charitable trusts and bequests in wills can be set up with the help of a professional adviser. The right advice will ensure that existing wealth is used for maximum benefit and that it is invested to grow long term for further distributions over time. An adviser may be able to facilitate access to tools from organisations such as the Impact Lab, which measures the impact of philanthropic giving and can calculate the return on investment of every dollar committed.
Philanthropists and their supporters have the reward and motivation of seeing exactly how much good their commitment is doing.