United States: Investing Through An International Trust

Prospective clients frequently ask me how an international trust can be used with investments. While every situation is different, there are some basic considerations you should follow.

Remember, using an international trust for investment purposes provides a number of financial planning opportunities, one of which is providing you greater investment diversification from global markets that would not otherwise be available to a U.S. citizen. And too, an international trust may allow you an opportunity to benefit from solid, legitimate tax planning.

Further, if privacy is important to you, an international trust can help keep prying eyes and potential busy bodies from knowing your every financial move. An international trust is also an excellent tool to obtain a high level of asset protection.

Finally, estate planning can, and should be, integrated into an international trust for retirement and inheritance purposes. These are just a few of the reasons for using an international trust for your investments.

When I first review a new client’s personal financial situation, I like to begin with looking at the big picture. This means that a complete listing of all assets, how they are titled, and the value of those assets, is essential. It’s kind of like looking at the fish bowl from the outside, rather than getting lost with the details from the inside.

Knowing what planning tools the client has used in the past, and what are in place today, is important. Understanding what objectives are sought for the future, is essential. Perhaps the most important question I ask is… Why? Having a good understanding of what makes a client tick, and why, is critical in making choices for a good planning structure for their investments.

By way of example, let’s say that Mr. Investor is a middle-aged man (ever notice how middle-age is always relative to your current age?). He owns a home with $275,000 in equity, which he treats as one of his investments. He also owns two real estate investment properties with $25,000 equity in one, and $290,000 in equity in the other. Personal property (jewelry, art, etc.) is valued at $35,000. He has been thrifty and accumulated $150,000 in tax-deferred investments (IRAs, pensions, and 401Ks), and another $225,000 in various stocks, bonds, and cash, acquired with after tax dollars.

Most of us would say our investor has done fairly well by having a current net worth of approximately $1,000,000. Since he still has earning-power years ahead of him, we will assume that mortgages and other debts will be paid down, after-tax investments over time will grow, and deferred income values will increase. Changes in the types of investments and values in future years are also certain to occur.

For now though, we will take a snapshot of our investor’s financial situation based upon today’s values. Several examples follow of how he might use an international trust with his present portfolio.

Mr. Investor presently owns all of his investments in his name and seeks greater diversification and higher yields. Presently, trading and investment opportunities for Mr. Investor are limited to only one-third of the world’s equity and bond investments. This is due to the stringent and over-burdening U.S. Federal regulations imposed on foreign institutions that simply refuse to deal with U.S. citizen-investors as a result.

If our investor instead used an international trust, he could open the doors to invest in quality equities and bonds in the other two-thirds of the world. By giving authority to his trustee, new banking or trading accounts could be opened allowing participation in investment grade opportunities that were closed off to our investor before. Our investor and the trust will still be subject to U.S. taxes and compliances issues, but diversification and greater investment opportunities could be achieved if he invested through an international trust.

Our investor also seeks greater protection from losing his real estate investments, his home, stocks, bonds, cash, and other personal property in our litigation-gone-mad-society. Since all of the assets are presently in his name personally – most of which took his lifetime to accumulate- one lawsuit could wipe out everything overnight.

A common misconception is that sufficient insurance will solve any lawsuit concern. But what happens if the claim is excluded from coverage? Or, what happens if the claim is in access of liability limits? This is not uncommon as juries regularly hand out multi-million dollars awards. Or, even if the claim is covered, what happens if the insurance company goes bankrupt and you are left holding the bag?

Unfortunately, I have witnessed all of these examples occur to unsuspecting good people, time and time again.

It is always a significant risk to hold title to your investments in your own name. The better approach is to control and use your assets from a separate entity, which holds title to the investments. Separating title from control is an essential step in planning to protect your investments. You control; the international trust holds title.

There are pros and cons of the benefits of using domestic planning structures vs. using international planning tools for owning investments. The comparison is not discussed here. But it is sufficient to state that while domestic structures have a benefit – something is always better than nothing - using an international trust for owning and controlling investments is generally far superior for a long list of reasons.

The first example of how Mr. Investor could use an international trust would be to re-title investments and certain other assets into a self-settled, international grantor trust. This means placing title to the home, real estate investments, personal property, and stocks, bonds and cash into the trust. A properly structured international trust could offer significant advantages over holding title to the property in his name. He would still be able to use and maintain control over these investments, consistent with the terms and provisions set forth in the trust documents.

Another common misconception is that using an international trust means transferring investments to an offshore, foreign destination. While this is always an option for Mr. Investor to consider if he is looking to broaden his investment horizons worldwide, it is not necessary. He can easily maintain his investments exactly where they are located today, with title held in the name of the international trust. As the comfort level increases with investing in other countries, investments can then be moved around at ease.

A properly structured international trust could permit Mr. Investor to use and occupy the home, make investment choices about the stocks, bonds and cash, and deal with the investment real estate in a similar manner as he had before. He could also readily receive cash distributions from the investments to live off of, if he desired. The big difference is that he is dealing with these assets in the name of the international trust, and not in his name. Structure and planning is everything in setting up the international trust to achieve these goals.

A huge benefit in the above example of placing investments into the international trust, is that if Mr. Investor is personally sued, he may have significant opportunities to keep his investments out of the reach of certain classes of creditors. Issues of fraudulent conveyances, collateralized assets, and other legal topics come into play, but are beyond the scope of discussion for now. Still, an international trust is a relatively uncomplicated and a commonly used planning structure for investment purposes… one of which may be to protect them from frivolous creditors.

One draw back to the above example is that if a lawsuit was filed against the trust arising from one of the real estate investments, all of the other investments and assets in the trust could be subject to the claim. In other words, the investments may be protected from litigation filed against him personally, but there are always risks when a lawsuit is filed directly against the trust with different investment classes of varying degrees of risk.

Even with the above being said, proper planning of an international trust can often significantly mitigate the risk of litigation against the trust directly. If the trust is set up properly, in a timely manner, and if formed in a jurisdiction offering the best protection for his investments, Mr. Investor could generally increase his chances of success in the outcome following litigation.

The more common use of an international trust to hold all investments is when they are all low risk assets, such as stocks, bonds and cash. This class of assets is considered less likely to be the subject of direct litigation as compared to real estate investments or other active business pursuits.

Since Mr. Investor has different types of investments with varying degrees of risk, a far better example would be for him to use an international trust to hold title to various entities. Each entity would hold title to his different types of investments.

It is important to note that proper planning always requires using the proper entity type for a particular investment. S-Corps, C-Corps, LLCs, and FLPs, are only a few of the choices on offer to hold title to investments.

Our investor could still maintain control over the assets, and the title could be removed yet another step away from a frivolous lawsuit. This type of planning offers far greater flexibility than the first example. The opportunities for diversifying investments, and broader asset protection planning for those investments, can also be accomplished.

For example, our investor could place title to his home in a single member limited liability company, domestic or offshore, which may provide for full tax advantages found in home ownership… he would be the manager of the LLC, maintaining full control and occupancy. This could effectively provide an opportunity for safeguarding the home and $275,000 in equity from the failings of other investments.

Then, the stocks, bonds and cash totaling $225,000 could be held in a family limited partnership, with our investor being the general partner, again with maintaining control over investment decisions. Keeping assets like stocks, bonds and cash separate from riskier assets, like real estate, is generally considered safe and conservative planning. The other personal investment property totaling $35,000 (the jewelry and art) could also be placed within this same entity, so long as none of these assets had high risk factors.

Our investor, in the name of the family limited partnership, could easily make trades within the portfolio. All income could pass through this entity, then through the trust, on to the investor.

However, keep in mind that certain types of investments could have a negative tax consequence if placed into this vehicle, so care must be taken with the type of investments transferred into it.

An important question for our investor to consider would be how to treat the two real estate investment properties. For example, should they both be held in one limited liability company? Or, should they be separated into two different LLCs?

An argument for each real estate investment to be placed into its own entity, is that litigation against the investment with only $25,000 in equity will not expose the other real estate investment with $290,000 in equity. A disadvantage is the cost and additional reporting requirements, which are generally minimal.

Alternatively, our investor could elect to keep both real estate investments into one LLC today if the lower equity investment is a low risk, and then segregate them in the future if risk intensifies, or as equity value increases. Otherwise, two separate LLCs today would be a risk-adverse choice. Our investor could still continue to manage and make rental decisions as he had before. The main difference is that he would be making these decisions on behalf of the limited liability company.

Great care must be taken with transferring investments that are considered tax-deferred. Transferring the $150,000 tax-deferred investments into another entity could, and probably will, trigger negative tax consequences. However, there are some exemptions to this rule, particularly if he was in the process of taking distributions at retirement age.

Sounds like you are complicating life when using an international trust for investment purposes? Not really. I have found repeatedly that once an investor’s structure is properly set up, tax advantages are more easily identified and achieved, instead of being overlooked. And too, once an investor gains more confidence in investing beyond the shores of the U.S., diversification and better yields are more easily realized.

An added benefit to using an international trust for investment is that the trust agreement is a private document. It is not filed in a public domain (like company documents or probating Wills), achieving greater levels of privacy. As noted above, integrating retirement planning and estate planning into an international trust is generally part of the planning process for our clients.

Naturally, the terms of the international trust must be carefully drafted, and the entity formalities must always be satisfied. A plan that is "one-size fits all" should be avoided, since it rarely fits anyone.

And importantly, when your international trust structure is created, it needs to be flexible enough to allow it to adjust to your investments and objectives as they change over time.

While there are common themes that run between many investors we consult with regularly, everyone is a little different. Customizing your plan to meet your investment needs is essential to reaching and maintaining investment objectives.

Action to take: Identify the best international trust structure for you to hold title and maintain control over your investments. Make certain that a qualified professional that can customize a plan to your investment needs creates the structure. Carefully planning for flexibility should always be considered to allow your structure to adjust to the changes in your investments, the changes in value, and the changes that happen in life.