Running your own business can be exciting, but it also comes with financial risk
While a simple sole trader or limited liability company structure may have served you well in the early stages of your business, as your personal wealth grows and your assets diversify, so should your ownership structure. Trusts are still an excellent tool for asset protection. Trusts have fallen out of favour recently with the introduction of the 39% income tax rate which came into effect on 1 April 2024. However, when used correctly, you can still enjoy the protection that Trusts offer whilst also avoiding the 39% tax rate.
Trusts are a great way for protecting non-income earning assets from creditors, like the family home or boat. As a company director, creditors can still hold you personally liable for company debts if you have allowed the company to enter into a transaction when you knew the company was or was likely to become unable to pay its debts. You can minimise your personal loss from creditors by transferring your assets to a Trust before any risk of a creditor claim arises.
PIE’s, including Kiwisaver or other managed fund, are taxed based on your Prescribed Tax Rate. This may be as low as 10.5% and capped at 28%, well below the 39% tax rate. Thus, you can still protect your PIE’s from creditors whilst avoiding the high Trust tax rate.
It’s not always possible to protect against creditors AND avoid a high rate of tax. However, under the De Minimis rule, a Trust will be taxed at the lower rate of 33% if the Trust’s net annual income after allowable tax deductions and distributions to all beneficiaries is $10,000 or less.
To optimize this, Trustees should consider making income distributions to beneficiaries before 31 March each year particularly if the beneficiaries personal income tax rate is 33% or lower. Your accountant can guide you on the best approach to reduce a Trust’s net taxable income.
A section 21 Agreement (a.k.a a pre-nup) is the surest way to prevent relationship property claims, however it is sometimes difficult to convince a partner to sign one. Under the right circumstances, transferring assets to a Trust before a relationship begins may keep them separate from future relationship property claims. However, this area of law is nuanced, particularly when the family home is involved, so professional legal advice is key.
Trusts can also provide long-term protection for your children’s inheritance. Retaining their inheritance in the Trust, or by having a well drafted memorandum of wishes directing how that beneficiary is to receive Trust property may safeguard your children’s inheritance against their own relationship property claims in the future.
Many of you will have a Will in place to direct who shall receive your inheritance on your death. Under the Family Protection Act 1955 however, your parents, spouse, de-facto partner, children, grandchildren and step-children can still challenge your Will if they believe they’ve been inadequately provided for. Assets held in Trust on the other hand generally fall outside the scope of such claims.
This article is for general informational purposes only and does not constitute legal advice. While every effort has been made to ensure the accuracy of the information, readers should not rely on this article as a substitute for professional legal advice.