Loan defaults, business failures, property attachments and legal complications are common problems that affect entrepreneurs, senior management professionals, business families, business owners and other such high and ultra high net worth individuals (HNIs and UHNIs). Such individuals and entities have begun to realise the importance of creating safety nets to safeguard their personal wealth. Safety nets offer protection against the fallout of unforeseen business and personal circumstances. Used the right way, they constitute legal ways of ring-fencing one's business, personal or family wealth.
Three factors must be considered: Timing, quantum and growth. Timing pertains to the question of whether the funds will be available when required or only at pre-determined time periods. Quantum relates to whether the mechanism in question can build a sizable corpus for the family, while growth refers to growing of wealth and beating the kind of inflation that HNIs experience.
Three safety nets are permissible under Indian law: Public Provident Fund (PPF), the Married Women's Property Act (MWPA) and Private Trusts.
Public Provident Fund
PPF is a non-encumberable asset, that is, it can't be attached under any circumstance, forming an automatic ring-fence. Easily purchased, it can be set up quickly and is a good choice for those not concerned about growth or return. Through PPF, the government itself wants to provide a safety net for the families of those who opt for it. Its main drawback is that access to the invested corpus is limited.
Returns are compromised, as one cannot invest money in equities when using PPF. Its inability to help meet lifestyle expenses is another drawback, as only a limited amount can be invested, and it generates returns at a predefined rate.
Married Women's Property Act (MWPA)
This has become increasingly popular in recent times, due to the efforts of life insurance companies. It involves purchasing an insurance policy under the Act. The aim is to safeguard married women's property from creditors. In the Act, any property belonging to a married woman stands protected from any income tax or legal liability her husband might have incurred. As with the PPF, again, the problem is access to the money. Further, the cost of life cover could be an unnecessary burden.
These are still at a relatively nascent stage in India. However, their acceptability as a safety net solution has been increasing among large business houses and HNI families. Not only do they help in prudent management of the wealth for kin who aren't investment-savvy but it can also serve to mitigate the possibility of wealth being eroded if inherited by family members who are either under-age or financially not very responsible.
How does one create a trust and manage it? Initially, the trust needs to be registered as a private one under the Trusts Act, 1964. Once registered, the first thing to focus on is the design.
The second and critical step is the conduct of the trust during its lifetime. For ensuring these steps are executed in the right manner, one needs a professional who has experience of both designing trusts and then helping conduct it, in a manner that is true in letter and spirit to the trust deed.
The prime advantage of this safety net is that even if the party that constitutes it is subject to liability, the funds in the trust cannot be attached. Such trusts also serve as a family investment account. Usually, the one for whom the trust is created becomes the managing trustee, while his confidantes, including the spouse and other family members, tend to become the second or third trustees. Ensure the individual creating the trust is not listed as a beneficiary. If this happens, the trust can no longer serve as a safety net.
One factor responsible for the popularity of private trusts as a safety net is that assets placed in it can be managed according to one's long-term financial goals. One can purchase real estate, bonds, mutual funds, insurance policies and more. In other words, the money in a trust can be invested in a wide range of customisable options.
Taxation: This is another aspect that needs to be considered when choosing the right safety net. While PPF remains the most tax-efficient instrument, along with the insurance purchased under the MWPA, it is inefficient from a returns perspective. While tax liabilities would arise from placing one's personal wealth in a private trust, the positive aspect is any money coming into the trust from the settlor is not taxable, provided the listed beneficiaries are close relatives. Further, money distributed by the trust to the beneficiaries is also not taxable. The trust can conduct any kind of investment activity that an individual can. The taxation of investments placed in the trust is the same as it is for individuals. Further, there are no tax slabs for trusts, as are applicable to individuals. While a trust can help plan for one's future generations, it cannot stand in place of a Will, making the latter an additional requisite for succession planning.
To create a private trust, one will require the services of someone with expertise in three distinct aspects: Legal, financial, and execution. It is only when all these are taken into consideration that this safety net will prove effective.
Safety nets are important not only for HNIs; everyone ought to set these up without fail. As long as the safety net is created with no mala fide intention and no nexus can be proven between the intent of creating it and any liability arising subsequently, the protected wealth can in no way be attached or appropriated, making it an excellent option in uncertain times such as these.
CONTINGENCY PLANNING IN SEVEN STEPS
One option is to buy PPF. Money in PPF account can't be attached
Buy insurance under the MWPA Act. It protects property belonging to women from liabilities that have arisen due to their husbands' actions
To create a private trust, take the help of an expert
Ensure both design and implementation are right
Avoid naming the person who has created the trust as its beneficiary
Invest in a whole host of investment instruments under the trust, thereby allowing the family's wealth to grow
- Avail of all permissible benefits under the trust structure