Much More than Tax Minimization: A Discussion on Trusts

Last week, Julia Chung and I met to talk about everything trust-related. For many non-financial advisors and their clients, trusts can seem complex, opaque and even a bit mysterious. We wanted to pull back the veil for those advisors and families who are just getting acquainted with trusts and discuss big picture questions like what they are, what purposes they serve, and the purposes they don’t serve. Our intention was not to get into the nuts and bolts, but rather try to think more conceptually about when - and how - trusts work best.

Here’s a sample of our conversation.

Kathy: It’s such a pleasure to speak with you, Julia, about trusts. Every conversation brings us just a little closer to understanding them more fully, and understanding when and how they can be valuable for families.

Let’s start by addressing the elephant in the room: why are trusts so confusing?

Julia: Trusts are confusing because they are not static. They are these made up entities with constantly changing structures, applications and benefits. This is not unique to trusts. So many of the things we deal with everyday are made up entities: corporations, stocks, bonds, markets. They exist because we created them as a society a long time ago to solve a problem or make transactions easier. And while they may have started as a simple means to an end, over time the rules, policies and conventions that govern them have increased and become more complicated.

Because trusts have very real implications for our lives, we think they should be concrete. As soon as we recognize them as abstractions, it becomes easier to forgive yourself some very natural (and normal) confusion.

Kathy: I can imagine for many families and advisors there is a sense of relief in that statement. Trusts are confusing not only because they’re abstract, but a really important piece that you began with is that the rules change all the time. Just when you think you are beginning to get a handle on what they mean, the rules of engagement change. So a very good strategy you may have developed becomes suddenly obsolete. Or begins to work differently than you expect. That’s definitely a really challenging aspect of trusts.

Julia: This is really important, actually. A lot of people don’t think about why they have the structure or strategy they have in place. The families I work with frequently come to me with a sort of unstructured system of assets (money, stock, businesses, etc.), which themselves have developed and shifted over time. But at very few points in their lifetime have these asset-holders stepped back and simplified things.

A trust is useless if you don’t have a reason why you’re doing what you are doing. What are you trying to achieve? Once families are clear about that, then we can start talking about whether or not a trust is the right solution.

Kathy: It’s a fair concern, but a lot of families I work with lead with tax - or more specifically tax minimization - as the key objective. When they lead with this, and let it drive the decision making, it’s often like putting the train’s caboose where the engine should go. A trust is a possible solution, but the real engine of decision making should originate in questions of continuity and core values. Maybe, just possibly, paying the least possible amount of taxes on assets doesn’t serve these bigger value-systems, visions, or goals for the family in a long term or bigger-picture way.

Julia: Exactly. We all need to ask ourselves these bigger, daunting questions: What am I trying to achieve? Why am I on this train and/or driving this train? Where are we trying to get to?

A trust can be a really effective tool to support the overall strategy, but it’s just one possibility in a slew of other equally possible options.

Kathy: In what contexts would you suggest a trust to a family?

Julia: I am going to focus on Canada to answer this one. In Canada, there are two broad forms of trusts - one that is created when you’re alive and the other that forms when you die. The most common one is the one that comes into existence through death.

The trust is essentially an entity that is almost a legal person: it exists to hold assets on behalf of other people (the beneficiaries). The trust has a responsibility to its beneficiaries. So if, for example, you are thinking about what may happen if you were to die when your kids are too young to manage money, you may Will your assets into a trust that manages them on their behalf. These are called testamentary trusts.

This is the most obvious and simple answer, but there are several different kinds of trusts, and - without getting into them more specifically - it really depends on a family or individual’s “why”. If we dig into bigger picture hopes, desires, or strategies, then we can make sure that vision is being served by whatever tool we choose.

Another key form is the living trust - or inter vivos trust - which is a trust that is set up while the asset holder is still alive. They can serve a number of purposes. For example, one form of inter vivos trust is the Alter Ego Trust, which helps with privacy concerns. Once a will goes to the probate system, all assets distributed are matters of public record. For high net-worth or famous families, an Alter Ego Trust can help temper that concern, as the distribution of assets, when it happens, occurs outside of the court system.

Trusts can also be useful for enterprising families with one or more operating businesses that they want to start transferring to the next generation over time. If the next generation is still young, and you want to begin building responsibility, this kind of slow transfer can be an effective way to prepare them.

Kathy: Families also rarely involve their children in the management of their assets, so trusts can be - in the right circumstances - an effective development tool for rising generations. A trust can be part of an ownership structure, for example, if a family has an operating business that they intend to eventually transfer ownership of to one or more of their kids down the line.

The ability of a trust to act as a tax shelter has changed quite a bit, and has been diminishing more recently, so thinking about other ways they can serve you will help make them more effective tools if you decide to put a trust in place.

Julia: Yes, and to circle back to where we began, it’s important to remember that trusts are fluid, and can be used as little or as much as an individual wants. If we move away from our limited perspective of trusts as a tax minimization tool, we may be able to use trusts - and the other tools available to us - to work in service of our bigger desires.

A trust can be an opportunity to pass on knowledge in an effective, thoughtful way. But they are time consuming and costly - trusts have to have tax returns filed every year and require administration and pay high tax rates - so they should be engaged with a lot of consideration.

Yes, it can be complicated and confusing, but if you have a really good advisory team that helps you think about what you are trying to achieve - in a long term, continuity sense - then they can help you make it simple.

Kathy: So much of our family advising comes down to trying to move toward simplicity and clarity. But it takes time, and we have to factor that in, too. When we’re unclear about what we’re really trying to achieve, things naturally get more complicated. Clarifying the goals early and often can help those tools and structures we use to achieve those goals more simple and more targeted.

Julia: That’s the simplest way to say it really: trusts work the best when they solve a problem. They are inherently neutral, so we have to ask ourselves the vital question “is this the right tool for what I am trying to do?”

Julia Chung is the co-founder and CEO of Spring Plans, a financial planning firm offering advice-only personal finance services. She also co-founded Admin Slayer, a virtual business services company, in 2015. Currently, Admin Slayer’s team of professional administrators, bookkeepers, social media managers & IT experts serves more than 140 companies globally. The co-author of several books, a Board Director for Family Enterprise Canada, and Vice President & Board Director for the Financial Planning Association of Canada, Julia was also recently honoured with a 2021 YWCA Women of Distinction Award.

Kathy Bright has worked with family enterprises for nearly twenty years. Her range includes hands-on experience with strategy and governance and she has acted as the President and an Officer of the Board for Family Enterprise Canada and Director of the Board of the Business Families Centre at UBC’s Sauder School of Business. Kathy’s interests include leadership, succession and continuity planning, strategy, risk management, governance structures, fiduciary responsibility, and the development and maintenance of positive relationships in family enterprises.