Estate Planning With Private Trust – Part 1

Much like a Will, a trust is also a very effective tool for estate planning. A creation of Trust benefits in many  situations where an individual wish to decide who control the assets and who benefits from them not only when they are alive but also when they are no more. Many Indian families are realizing the importance of creating a trust and thus using this tool while planning for future of their estate. Apart from the different types of trust structures which can be created in different situations, a trust brings  many tax advantages with it. It then becomes necessary that even financial advisors  should have a good understanding of a trust so that it can be included on their client’s estate plan if the situation demands.

What Is A Trust?

In simple words, A trust is an arrangement wherein a person (trustee) or group of person (Trustees)holds property as the nominal owner for the benefit of one or more beneficiaries. The arrangement derives its benefit from the fact that the trust is a separate tax entity which is the owner of  the properties and not any individual. Thus, a trust is free from any personal claim or even court  attachments in most situation.   Indian Trust Act 1882 is the act under which trusts are formed and managed.

A  trust, in general, will have following elements:

1. The author or settlor of the trust (Person who creates a trust)
2. The trustee/s (Person/s who manages the trust)
3. The beneficiary/ies (for whom the trust is created)
4. The trust property or subject matter of the trust ( assets managed by the trust)
5. The objects of the trust ( trust purpose)

Private Trust

Although there are various types of trust structures which can be created, Indian tax laws define the trust in 2 structures- Public and Private. Both these structures differ in their features and taxation. As the name suggests, a public trust is created mainly for the benefit of public at large while a private trust is constituted for the benefit of individuals. But the major difference between these two types of trust is that in a private trust the beneficiaries are specific individuals who can be identified clearly while in a public trust they are general public who cannot be ascertained. Although both the trust can be formed we will limit our discussion to Private Trust which has a greater role in an individual estate planning.

A private trust can be created either  by a Will or by a Non-Testamentary instrument called the trust deed. For immovable properties, a registered trust deed is mandatory but for movable properties a trust can be created simply by transferring the ownership of that property to the trustee/s. A private trust is further classified into two types- Specific Trust and Discretionary Trust. In  a Specific Trust structure, the beneficiary and their share in the property or income is clearly defined in the trust document. So when a private trust deed says that both the beneficiary will get the income in the ratio of 60: 40 then the description will come under a specific trust. Contrary to this in a Discretionary Trust the beneficiaries may be defined but their share of the property or income is not defined and the distribution of income among the beneficiaries is left to the trustees discretion.

A private trust can be created in 3 different structures-   Revocable, Irrevocable and Testamentary.

• Revocable Trust

As the name suggests it is a type of trust which the settlor or creator of the trust can revoke it anytime. If the settlor dies with the structure in place then the trust by default gets converted into an irrevocable trust. Since you can revoke the trust at any time there is no need to get the assets transferred. The income from these assets is added to the settlor’s income. Due to this reason the taxation of revocable trusts as good as the settlor’s taxation. Effectively this type of trust does not help you in your taxation but the structure gives you an ease of managing a situation like properties spread in different states.

• Irrevocable Trust

The other and most effective structure is an irrevocable trust. Once created there is no provision to revoke the trust which simply means the assets once transferred to these trust become the trust property. So Effectively under this trust structure the ownership of the asset gets transferred to the trust with the transfer of assets. This type of trust is most beneficial and mostly utilized by specially abled children families. Even parents with minor children who wish to keep the legacy protected for their benefit can create an irrevocable trust to meet their objective. The taxation of the trust is based on two different situations –specific or discretionary.  The irrevocable trust is most suitable where you wish to have asset protection for the life of the beneficiary such as special need children’s.

• Testamentary Trust

The third type of trust is testamentary trust i.e. trust created through a Will. In this type of trust, you actually write the terms of the trust in the Will itself and appoint your trustees in it. At the time of the execution of the Will, the trust is created.  This structure does not avoid probate since it has to be created through execution of a Will but appointing trustees for the legacy goes in favor of your minor children’s.

This article is part of a write-up on private trust authored by me and published in Financial Planning Journal,  FPSB, January 2016. In next few more series I will cover the other parts of the write up which will carry taxation of private trust, whom to appoint as trustees and a checklist to create a private trust.