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PLEASE NOTE: This article was published on the date listed below and may now contain information that has since been updated or changed. We have retained this article as it may still contain helpful comments. However, we advise you to make an appointment to see us for the most up to date information on this topic.

September 2004

Distributions

Assisting Family Trust Beneficiaries

Trustees of discretionary Family Trusts have considerable flexibility in assisting beneficiaries of Family Trusts. One option available to Trustees is to provide financial assistance to beneficiaries by way of loan rather than by distribution.

What is a distribution?

Trustees may make payments to discretionary beneficiaries in accordance with the terms of the Deed of Trust. These payments are called distributions. There is no gift duty payable on a distribution as it is not a gift. When a beneficiary receives a distribution it is theirs to keep. The payment becomes an asset of the beneficiary. The Trustees can not ask for repayment.

What is a loan?

Trustees may loan an amount of money to a beneficiary on the understanding that the beneficiary will repay the money at an agreed time in the future with an agreed interest component. Frequently, the time period will be “upon demand” (whenever the Trustees give notice requiring repayment). Frequently, the loan will be interest-free. The money can be used by the beneficiary but is not an asset of the beneficiary as it eventually has to be repaid.

What are the advantages of a loan?

  • It gives the beneficiary use of funds, which the beneficiary may not otherwise have got;
  • It gives the beneficiary use of funds without giving ownership rights;
  • Where the loan is interest-free, there is no cost to the beneficiary;
  • If a beneficiary is in business, which runs into financial difficulties, the funds may be more protected if they are a loan rather than a distribution, which would become proprietor’s capital;
  • If a beneficiary is in a relationship, the funds can not be claimed as relationship property by the beneficiary’s partner or spouse as the loan is a debt not an asset of the beneficiary.

An example
We often quote the example of a Family Trust that has $100,000 cash available. One beneficiary approaches the Trustees for a distribution of that amount to enable the beneficiary to buy a home for the beneficiary and spouse/partner.

House $300,000
Bank loan $200,000
Shortfall $100,000

The Trustees decline to make a distribution but instead agree to a loan (interest-free, repayable upon demand) for $100,000 to the beneficiary. The house is bought with the beneficiary and spouse/partner residing in it.
Three years later the beneficiary’s relationship comes to an end. In our example (to keep the mathematics simple) the house has not gone up in value and no principal has been paid off the bank loan. The spouse/partner claims one-half of the equity under the Property (Relationships) Act.

House $300,000
Bank loan $200,000
Equity $100,000
÷ 2 = $50,000

But then the Trustees remind the beneficiary that the Trust loan has to be repaid.

House $300,000
Bank loan $200,000
Trust loan $100,000
Equity NIL
÷ 2 = NIL

The spouse/partner can still claim under the Act but subject to the Trust loan being repaid. The couple can settle all other relationship property issues. Then the Trustees can re-advance the original amount to the beneficiary to enable the beneficiary to get life underway again. If this had been a distribution the spouse/partner would have been $50,000 better off. As it is the spouse/partner gets nothing.

Can a loan be forgiven?

At any time the Trustees can convert the Trust loan into a distribution. However, it should be remembered that a Family Trust is formed with the intention of protecting family assets. By distributing funds (rather than making loans) before the Trust is wound up may defeat a primary purpose of having a Trust in the first place.

Conclusions

We believe that the Trust loan concept gives both the Trustees and beneficiaries greater flexibility as well as greater protection for the beneficiaries. We particularly find that clients, when forming a Family Trust are keen to adopt the Trust loan concept in their memorandum of wishes addressed to their Trustees.

This article gives an indication as to how this arrangement can work. However, it is important that you discuss matters with us first to ensure that your intentions are effectively documented.