There are different types of trusts for different purposes depending on the settlor’s needs and goals. However, the essential characteristic of all trusts is the separation of legal and beneficial ownership. The settlor transfers the asset to be held in trust to the trustee (who then becomes the legal owner) who owes fiduciary duties towards the beneficiaries (who are the beneficial owners) and must act in the beneficiaries’ best interests. For a more general introduction on trusts, please refer to our previous article “An Introduction to Trusts – A Medieval Concept Still Relevant Today”.
Generally speaking, trusts can be separated into three categories: (1) inter vivos or testamentary; (2) revocable or irrevocable; (3) fixed or discretionary. The categories may overlap. For example, one of the most common estate planning tools is an inter vivos irrevocable discretionary trust. Each type of trust is explained in more detail below.
Inter vivos trust (also known as Living Trust)
This type of trust is created during the settlor’s lifetime. Ownership of the assets is passed to the trustee when such assets are injected into the trust by the settlor. The trust can begin to operate (i.e. benefit the beneficiaries) as soon as the assets have been injected into the trust. It is common for this type of trust to benefit the settlor during the settlor’s lifetime and continue to benefit the settlor’s surviving family members and/or charities after the settlor’s death. An inter vivos trust can be revocable or irrevocable. The trustee can be given lots of discretion or the settlor can retain more control depending on how the trust deed is drafted.
Testamentary trust (also known as Will Trust)
A testamentary trust is formed under the terms of the will. The will should include trust provisions (like those in a trust deed) to govern the trustee’s powers and obligations. The settlor is the testator (will-maker) and the trustee is usually the executor. The trust fund is the residuary estate (i.e. the estate after any debts/expenses had been paid and any specific legacy under the will had been distributed). Ownership of the assets remains with the settlor testator until his death and the probate process must be completed before the trustee can benefit beneficiaries. In short, the trust is only created upon the settlor’s passing.
A revocable trust can be changed or revoked by the settlor at any time and the trust assets would revert back to the settlor. Although this gives the settlor more flexibility and room to change his mind, it is less useful in terms of asset protection (for example, if the settlor is being sued, the trust assets may still be deemed as the settlor’s assets and subject to third-party claims).
An irrevocable trust cannot be revoked after the trust deed has been signed and the assets have been injected into the trust. The beneficiaries’ interests under an irrevocable trust are more secured. Since the settlor gives up control, asset protection is more effective.
Each beneficiary’s entitlement to the trust fund under the trust is specifically set out in the trust deed and the trustee has no discretion regarding the distribution of the trust fund. This type of trust is most certain, but the trustee is less equipped to deal with contingencies that may arise in the future. For example, if a beneficiary is subject to divorce or third-party claims, the trustee may not have discretion to suspend distribution until after the situation is resolved. Or if a beneficiary suddenly requires funds in the event of a medical emergency, the trustee may not have the discretion to make a bigger distribution for that beneficiary.
Each beneficiary’s entitlement to the trust fund under the trust is not fixed and the trustee is given many powers and flexibility to deal with changes in circumstances such as death or divorce of a beneficiary, changes in tax regimes and legislations. Distributions can be in different amounts, in different stages or contingent upon certain conditions. Because a discretionary trust confers so much flexibility, it is typically accompanied by a more detailed letter of wishes which sets out the settlor’s instructions as to how to exercise discretion, distribution timing, guidelines and conditions, circumstances for suspension of distribution and etcetera. Although a letter of wishes is non-binding, most trustees, especially professional trustees, typically follow the guidance contained therein.
In addition to the above categories, there are also trusts specific for tax planning. Such as a foreign grantor trust to avoid US federal gift and estate tax for non-US settlors who wish to benefit US beneficiaries. However, no trust can eliminate the need to make a will (except for a testamentary trust which is created by the will itself) because if there are any assets not transferred into the trust right before the settlor’s death, these will be disposed of in accordance with intestacy laws, which may not correspond with the settlor’s wishes. Moreover, depending on the type of asset, transfers to a trust may carry stamp duty or tax whereas estate duty has been abolished in Hong Kong (i.e. there is no tax against a bequest under will). For many clients, the best solution is a standby trust used in conjunction with a pour-over will whereby the settlor retains control over his assets in his lifetime and upon his death, the majority of his estate will be transferred to the stand-by trust (created during his lifetime) via his will to be managed by the trustees in the best interests of the beneficiaries.
If you think you need a trust as part of your estate planning but have no idea which type of trust is right for you, we can assist you and ensure that your estate planning is as complete as possible.
Our team at Hugill & Ip has extensive experience in dealing with Estate Planning and Trust issues – so if you need further advice on these subject, get in touch with us.
This article is for information purposes only. Its contents do not constitute legal advice and readers should not regard this article as a substitute for detailed advice in individual instances.