One time when I was in Burma (now Myanmar), I spent a couple of days riding around the forest by elephant back. Elephants are a fine thing to have in the forest but, believe it or not, you have one living in your house with you. And you should do something about it now, before your house is wrecked and you and your family get stomped in the process.
Any amount of financial success won’t mean much if you get stepped on by the elephant in the room. The damage you routinely suffer from the elephant—not to mention the lingering threat that he’ll go completely berserk someday—dwarfs the importance of the best investment decision you’ll ever make. So, I’m going to invite your attention to a problem of overriding importance: How can you protect yourself and your wealth from the elephant?
The elephant in the room is, of course, the government.
The elephant is your permanent roommate, and it has a permanently big appetite. In the name of “income tax,” it regularly eats 40% or so of everything you earn. You may not like it, but by now you’ve probably learned to live with it.
After you’ve lived out your income-tax paying years, the elephant will attend your funeral—not to console the mourners or to recount your good deeds, but to collect estate tax. In the name of the “estate tax,” the government will take up to 40% of what you leave for the next generation and perhaps more of what you leave for your grandchildren.
It’s not the kind of roommate you’d advertise for. In fact, if you add things up, government probably is the most expensive disaster you’ll ever suffer. Almost every year, you lose more to it in taxes than you lose on your worst investments. And unless you’re a champion crime victim, you’ll lose less to a lifetime’s worth of burglars, bandits, muggers, and con men than your estate will lose to the tax collector… if you don’t do something about it.
Most successful people respond to the elephant by trying harder—working harder, working smarter, and earning enough to live well on what the elephant doesn’t eat. They’re like the farmer who plants enough to have a good harvest even after the bugs have taken their share. This is a workable solution, up to a point. But it won’t work at all if the elephant decides to take everything.
The idea of losing everything is literally unthinkable for many people. It is so far outside the range of their experience that all they can do with the idea is to reject it as not worth considering. Unfortunately, this also means rejecting all the opportunities for protection—just as many Titanic passengers shunned the early invitations to a lifeboat.
But the danger of a total wealth wipeout doesn’t go away. Some people do in fact lose everything to the elephant. In a few cases, it happens through seizures. A government agency points to an individual, calls him a bad name (drug trafficker, money launderer, polluter, racketeer, or tax evader), and takes everything the target owns. The target may not even have enough money left to hire a lawyer to help recover a portion of what he’s lost.
More commonly, it’s a lawsuit that takes everything a person has. The judge hears a story. The judge likes the story. The judge orders the defendant to give the plaintiff everything the defendant owns. Then the plaintiff wonders why a seat in the lifeboat seemed so uncongenial.
The best protection you can have from the elephant is not to own anything. What you don’t own can’t be taken from you by a tax collector, by a government agency, by a results-oriented judge, or by anyone else. You don’t want to be poor, obviously. But there’s a strategy that lets you have it both ways—the safety of not owning anything and the benefits of being wealthy. You can have it both ways by transferring your assets into an institution in another country that will return them to you (or family members) only when you want them back.
That’s the essence of an international trust. It puts just enough distance between you and your assets that the assets can’t be taken from you. But it makes those assets available to you when you want them. An international trust needs to be designed in just the right way. It mustn’t leave you with any rights that a local court or government agency might try to take away from you; and it mustn’t leave you with any powers you could be forced to use against your wishes. On the other hand, the trust must give you emphatic assurance that the trustee will never lose sight of your real objectives—otherwise you’re not going to use it.
Here’s an outline of how an international trust protects you from the elephant:
- You are the grantor of the trust—the person who transfers legal title to selected assets to the trustee.
- The trustee is a bank or trust company in a country with no income or estate taxes and a legal system that won’t tolerate a US-style litigation explosion. The trustee takes legal responsibility for the safekeeping of trust property and applying it for your purposes.
- You and everyone else you care to include are the beneficiaries—the persons who are eligible to receive cash distributions or other benefits from the trust. You can include family members (including descendants who haven’t been born yet), or anyone else.
- You are the protector of the trust. As protector, you have the legal power to monitor the trustee’s performance and the power to replace it with another institution if needed. You also have the power to name your successor as protector—so that the trust will continue to have a protector even after your lifetime.
The relationship among the participants is spelled out in a written trust agreement. Two provisions are essential to getting maximum protection. First, the trust should be irrevocable. If it isn’t, then anyone can undo your trust simply by forcing you to revoke it.
Second, the trust should be discretionary. “Discretionary” means that no one beneficiary owns a particular share of the trust. Instead, each beneficiary receives what the trustee, in its discretion, decides to give the beneficiary. With a discretionary trust, no beneficiary owns anything he can be forced to assign to a judgment creditor or tax collector. And a discretionary trust makes it impossible for any tax collector to attribute the trust’s income to a beneficiary.
These two key features—irrevocable and discretionary—are both powerful and cautionary. They are powerful in that they put up a wall around your assets that the elephant can’t knock down. The elephant can’t reach trust assets directly, because they’re held by an institution offshore, where US courts and government agencies have no jurisdiction or power to enforce a judgment. And it can’t reach them through you because you don’t have the power to get them back without the consent of the trustee. You can do or sign whatever you’re ordered to and still be confident that your wealth is protected.
But that same power is a source of caution. How can you be confident that the trustee will use the discretionary authority you’ve given it in the right way? How can you be confident that the trustee will send you a check when you need it? You get that confidence by being the protector.
The trust agreement should give you, the protector, the power to replace the trustee with another institution of your liking—in other words, you should have the power to fire the trustee.
Two other features should be included to ensure that the trustee uses its discretionary authority correctly. First, the trustee should be obligated to consider all the advice it gets from the protector. Second, the trustee should be absolved of liability for decisions it makes based on the protector’s advice. Together with the power to fire the trustee, these provisions give the protector all the influence he needs.
Using an international trust for lawsuit protection and tax savings doesn’t interfere with your freedom to make investment decisions. If you want, the trustee can open a brokerage account for your trust anywhere in the world and appoint you as the trading advisor. You continue to give the buy and sell orders. Or you can ask the trustee to hire a particular investment manager for your trust. Or you can keep complete management control by using a limited partnership. You transfer the real estate, business, or investments you want to protect to a limited partnership and then transfer the limited partnership interest to the trust. As general partner, you would still make the day-to-day investment and management decisions, but the value of the assets is protected by the trust.
The biggest, simplest benefit of an international trust is lawsuit protection. You can’t be forced to hand your assets over to the winner of a lawsuit (or to any other creditor), because you no longer own them. The trustee is the legal owner. Anyone who hopes to reach those assets must bear the expense and bad odds of legal action in another country. Provided you’ve selected the right country for your trust and assuming that you were solvent when you funded it, his prospects are extremely dim.
Plaintiffs’ lawyers know how difficult it is to break into a properly established international trust. As a result, having your assets protected by an international trust means that litigation against you never gets started or gets settled on terms that are extremely favorable for you.
Income tax savings for yourself aren’t automatic. They depend on how your trust investments are structured. This is a complex topic, but the summary is short: Merely transferring assets to an international trust won’t achieve any income tax savings in your lifetime.
For future generations, the income tax consequences of an international trust are far more dramatic. The trust will have no ties to the US tax system. It can be used to accumulate and compound investment returns free of current income tax. Future generations will face no tax on the profits until they spend them. Even then much of what they take from the trust can come to them free of income tax. An international trust allows you to pursue any type of estate plan you want (or none at all). You can do all the conventional things you’re likely to hear about if you visit an estate planner, and also do some other things that wouldn’t be possible without going international. For example, with an international trust, you can get property out of your estate and still be eligible to receive the money back for your own support if you later find that you need it. This frees you to act aggressively to reduce your taxable estate without the fear of planning yourself into the poorhouse.
The biggest estate-planning advantage is finality. The wealth you leave in an international trust disconnects from the US tax system. It will never be included in the taxable estate of any future generation. For your family, estate tax comes to an end. The elephant will have to dine elsewhere.
Previously, getting the protection of an international trust demanded so much effort and expense that almost no one did it. But now an international trust is cheap and easy to use.
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