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What is a Trust? Why Create a Trust and How Does it Work?

What is a Trust?

Trust can be defined as :

• Public trust
• Private trust

A public trust is created for religious and charitable purposes or for community development. This trust cannot be used to transfer wealth to your beneficiary (children).No formal deed is required for creating a public trust. A private trust is used to transfer wealth to your heirs (children).These trusts have to be compulsorily created/registered and Governed under the Indian Trusts Act 1882. In a private trust you (Settlor) can transfer your movable property such as a car as well as immovable property such as property or land to the trustee (person who holds the property on behalf of your beneficiary/children). A formal document or an agreement is necessary if the trust holds your immovable property such as land or property. This agreement is not necessary for movable property such as a car.
You can transfer shares/mutual funds, fixed deposits, cars, land, apartments/house, gold, art as well as antiques to the trust.

What are the benefits of a trust?

  • A trust can be used for the education (college studies) of your children.
  • It can be used to transfer wealth to a child with special needs (disabled children).
  • For your elderly parents who might have high medical costs.
  • If you cannot trust your children with your wealth as you believe they will waste it then you can keep it in a trust till your child is mature enough say 35 years of age .He/She cannot touch this money till they attain that age.
  • Your wealth is held in a trust and is protected from family fights and feuds.
  • Your son might be divorced and has to pay alimony (money for maintenance) this wife A trust prevents your assets from being used to pay the alimony.
  • You might suffer a loss in business and a trust prevents your assets transferred from being seized to make up for this loss.

How does a trust work?

In a trust you the settler (owner of the property) transfer your assets to a trustee (could be your lawyer) to hold them on behalf of your beneficiary (children).The trustee is the executor (manager of the assets) on behalf of your beneficiary and ensures that your wealth reaches the beneficiary irrespective of what happens to you. Revocable trust : The trust can be revocable where your assets even though transferred to the trust are still yours. You can change the beneficiaries of the trust. If you have been estranged (separated due to a fight) from one of your sons and daughters and left him/her out of the trust and now you are back on friendly terms you can make him/her a beneficiary (share in your property) if the trust is revocable.

Irrevocable trust : In an irrevocable trust after you transfer your assets tthe trustee you no longer are the owner of your assets. The trustee is the owner of the assets on behalf of your beneficiary. You no longer own these assets and they now belong to your children. The trustee will hand over these assets to your children at the specified time say when the child is 18 years of age. If you have transferred your property to your children and left one of your child out of your property due to a fight which is now patched up (over) you cannot add him/her as a beneficiary unless your other children agree to this if the trust is an irrevocable trust.

An irrevocable trust protects your assets as in case you suffer a business loss or a divorce your assets which have been transferred reach your children as your creditors or your separated wife cannot touch these assets.

What should you take note of when creating a trust?

  • You need to be certain of your beneficiary (Clearing define your beneficiary as your son or daughter).
  • Never make a beneficiary a trustee as he is pulled between the call of duty and his own needs.
  • The trust needs to mention the date on which the beneficiary becomes the owner of the property.
  • The trust as per Indian law cannot exceed 25 years and the trust must be closed before this time.
  • A private trust can be a discretionary trust where you specify only the names of the beneficiaries. The trustee decides on the proportions.(Which beneficiary should get how much).
  • In a non discretionary trust you decide what proportion each beneficiary gets. The trustee manages the fund but cannot change the proportion each beneficiary gets.

How is the private trust taxed?

In a non discretionary trust all income obtained from the instruments (property or land) transferred to the trust is taxed in the hands of the beneficiaries (your children).

If your child is a minor this income is clubbed to either your income or your spouse’s income depending on whearns more and taxed. In a discretionary trust the income from your assets transferred to the trust are taxed in the hands of the trust.

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