In my experience, 75 per cent of family trusts in New Zealand could be overturned as shams. This is not because of the way they have been established - most trusts here are reasonably well set up. Instead, it is the way they are managed that creates the risk they could be set aside.
A sham trust is one which gives the appearance of the creation of a trust when in reality it is just you in another guise - the trust is your alter ego.
The IRD, a creditor, WINZ or a business partner may attack the trust and try to get a court to "see through" it as being a sham.
Alternatively, the attacker may be a beneficiary, probably a disgruntled family member, claiming you have managed the trust imprudently and solely for your own benefit, with no consideration given to any of the trust's other beneficiaries.
The big problem is most people manage the assets in a family trust as their own. In fact, once a trust is set up and assets sold into it, these assets are no longer yours - they are the trust's and must be managed for the benefit of all beneficiaries.
If trustees continue to treat assets as their own personal property, someone attacking the trust can claim there was no genuine intention to form a trust.
They would effectively be saying you have established a trust but the way you have managed it and treated its assets shows there has been no substance to its arrangement.
Consider some common examples. Imagine you live in a house owned by a trust and wish to build an extension. Many people would pay for the addition themselves. However, because the property belongs to the trust, you should lend funds to the trust so it can pay the builders for the addition.
Another example is putting a rental property into a family trust but asking tenants to pay rent into a personal account instead of the trust's bank account.
These examples show trustees dealing with the property as if it is their own, and would be good evidence if someone was trying to show the trust is really your alter ego.
Good management means involving all of the trustees in decisions, holding regular meetings, keeping good records and considering the positions of all beneficiaries.
This does not mean you making distributions to other beneficiaries - but to ignore them is to court disaster.
Family trusts are like an insurance policy in that they are designed protect you from something adverse.
Poor management is likely to void the policy, which is a bit like paying the premiums for your house and contents insurance but going out and leaving the doors wide open.
Each week financial author Martin Hawes shares strategies to help you grow your wealth. You can email finance questions to firstname.lastname@example.org or email@example.com On the web: www.wealthcoaches.net