I’ve had several conversations with clients lately about trusts that have given me pause. Some of these discussions have started with a client pulling out a trust deed that was settled years ago, and explaining that circumstances have changed. Family dynamics have shifted and a beneficiary has become estranged, or an excluded family member has come back into the fold. Other times a beneficiary’s circumstances have changed, such that the client no longer sees the need to include them in an otherwise mandatory distribution. Inevitably the client asks how they can change the trust to reflect current circumstances.
A related conversation often arises during estate planning. When I ask a client to summarize their assets, they include property that was transferred to a trust years ago. They refer to trust assets as “mine”, even though legal ownership was transferred to a trust long ago.
Both situations point to the same misconception: once property is transferred to a trust, it generally no longer belongs to the person who settled the trust. It is not simply a Will that takes effect early. Once settled, the beneficiaries of the trust have certain rights and expectations in respect of the trust property.
There are, of course, exceptions and variations. Alter ego trusts and joint partner trusts, for example, are typically structured in a way to allow the settlor to retain significant benefits during their lifetime. The trust may continue to feel very much like an extension of their personal affairs. Even in those cases, however, it is important to remember that the assets are held by the trust, not personally by the settlor.
The misunderstanding often becomes most apparent when clients want to change the beneficiaries of a trust. Many people assume that because they originally settled the trust, they can later decide who should benefit from it. In many trusts, that is simply not the case. Unlike a Will, which can be revoked or amended so long as the testator has capacity, trust terms are often difficult to change once established, and, depending on the terms of the trust, may require an application for court approval. The result can be a frustrating disconnect between what clients think they have created and the legal reality of the structure.
Of course, trusts remain useful tools for purposes including tax and succession planning, asset protection, income splitting, and incapacity planning, and a well-structured trust with appropriately chosen trustees may allow for the necessary level of flexibility to adapt to changing circumstances. But trusts achieve those noted benefits precisely because the settlor gives up certain rights and control. This important trade-off needs to be understood from the outset.
As advisors, we spend a great deal of time explaining tax consequences and administrative requirements. We should devote equal attention to explaining the ownership consequences of creating a trust. Clients should understand that trust property is not simply their property in a different place. A little extra discussion at the planning stage may prevent a great deal of surprise years later when the trust deed is pulled out of the filing cabinet and a client asks a question that has a much more complicated answer than they expected.
