Differences between a Trust and a Foundation

Two of the most powerful financial vehicles available for asset protection and estate planning are Trusts and Foundations. Both of these vehicles provide a means to protect your assets while you are alive, and to secure them for easy transfer to your heirs upon death. 

While these two instruments have many similarities and common uses, there are also important distinguishing characteristics that set them apart. Deciding which is the ideal choice for you depends on various factors related to your personal circumstances and needs. 

In this article, we will start by giving a brief overview of what exactly a trust and a foundation is. We will then examine some key differences between them, look at the benefits that they both provide, and then discuss which is the best choice. 

Table of Contents:

• What is a Trust?
• What is a Foundation?
• Differences between a Trust and a Foundation
• Structure
• Uses
• Taxation
• Benefits of Trusts and Foundations
• Which is Right for You?

What is a Trust?

At its simplest, a trust is an agreement between three parties: the grantor/settlor, the trustee, and the beneficiary/ies. When a trust is formed, the grantor of the trust transfers ownership of assets into the trust which are then managed by the trustee for the future benefit of the beneficiaries. There are various types of trusts; each with their own unique terms and structures. These include: 

• Revocable Living Trusts
• Irrevocable Trusts
• Asset Protection Trusts
• Land Trusts
• Charitable Remainder Trusts
• Spendthrift Trusts

Some trusts, such as an asset protection trust, are ideal for use as personal asset protection vehicles because they allow the grantor to simultaneously be the sole beneficiary of the trust. Other trusts, such as revocable living trusts, are better suited as estate planning vehicles as they allow for easy transfer of assets to the grantor’s beneficiaries upon death, whilst avoiding probate procedures. 

Revocable trusts are those where the terms of the trust can be altered or terminated altogether by the grantor (i.e., the grantor effectively retains ownership and control of the assets in the trust). In contrast, an irrevocable trust cannot be changed or terminated by the grantor of the trust once it is in effect, and thus the grantor gives up all personal control and ownership of the assets once they are transferred to the trust (except in rare cases such as in the case of a well-structured Asset Protection Trust). 

In general, trusts are used for estate planning, asset protection, tax optimisation, and financial privacy.

What is a Foundation?

A foundation (often referred to as a “Private Foundation”), is a special type of tax-exempt organisation that does not qualify as a stand-alone public charity, but rather it typically makes donations to other charities. These donations are called “grants”. 

A foundation is allowed to make grants for the following purposes:

• To fund an organisation’s general operating expenses
• To fund a specific program that an organisation is running
• To individuals, provided they follow the IRS rules for a tax-exempt foundation

The final point is important, because it means that foundations can in fact be used in estate planning to transfer assets to individual beneficiaries. However, in order to maintain its tax-exempt status, a foundation must benefit the public in some way. This usually involves some type of charitable donations. Foundations can be used to optimise taxes due to their tax-exempt status, and offer an ideal vehicle through which to give charitable donations, transfer funds to individual heirs, and protect the assets which are transferred into the foundation. 

The 501(c)(3) of the Internal Revenue Code outlines strict requirements that a foundation must adhere to in order to maintain its status as a tax-exempt entity. 

Differences between a Trust and a Foundation

Structure

A trust is an agreement between three parties: the grantor, the trustee, and the beneficiary. The trustee is responsible for overseeing the assets in the trust and acting in the best interest of all parties involved. Certain types of trusts allow one party to hold more than one of the three roles above (e.g., grantor and trustee in the case of a revocable trust; or grantor and beneficiary in the case of an asset protection trust).

A foundation, on the other hand, is its own stand-alone legal entity. It is a non-profit organisation that qualifies for tax exemption. It benefits charities and/or individuals by providing direct grants with the foundation’s assets. It may also engage in other activities aside from issuing grants. The person who forms a foundation is known as the founder, and it is typically managed by a board of directors / counsel. 

Uses

Trusts are usually used for:

• Estate planning – as a means to transfer assets efficiently and cost-effectively to heirs after death
• Asset protection – special asset protection trusts can be formed to safeguard personal wealth from lawsuits, creditors, and other risks
• Land ownership vehicle – land trusts can be used to hold land on behalf of the grantor or for future benefit of the trust beneficiaries

Foundations are used for:

• Charity – foundations are excellent vehicles through which to give charitable grants in a tax efficient manner, which are not in the personal name of the founder of the foundation.
• Creating a legacy – foundations can be formed in a family or loved one’s name, which allow them to be honored even after death.
• Tax optimisation – private foundations enjoy special tax exemptions. Cash and property contributions made to a foundation are often tax-free, and donations made to a foundation are tax deductible.
• Estate transfer – foundations can issue grants directly for the benefit of an individual, which means they can be used as a means to transfer your wealth to your heirs after death

Taxation

Trusts are taxed differently depending on the specific type, as well as the jurisdiction in which they are established. Irrevocable trusts are taxed as stand-alone legal entities. They have their own tax number and are taxed in accordance with the tax rates applicable to trust funds in the jurisdiction in which they are based. Revocable trusts are often taxed as pass-through entities, and the grantor is therefore responsible for paying tax on the assets in their own personal capacity. However, both may allow for greater tax efficiency compared to personal ownership of the assets in question.

Foundations are exempt from most types of taxation in majority of jurisdictions. They are non-profit organisations which offer tax optimisation as one of their primary advantages. In order to qualify for tax exemptions, a foundation must:

• Donate at least 5% of its endowment in a way that does not benefit a private individual
• Not own or operate a for-profit business
• File comprehensive annual reports and conduct independent audits
• Meet all accounting requirements of non-profit organisations. 

Benefits of Trusts and Foundations

While trusts and foundations differ quite significantly in their nature, uses, and relative advantages, there are some benefits which are common to both. These include:

• They both provide a good degree of flexibility in that their terms can be tailored and adapted to suit the specific needs of the founder/grantor and beneficiaries. Irrevocable trusts offer less flexibility.
• They both allow the grantor/founder to maintain some form of power in making decisions about the trust/foundation assets, or overruling decisions made by the trustee or foundation board.
• They can both be set up in perpetuity (there is no expiry). This makes them ideal for holding family wealth and assets over multiple generations.
• Both foundations and trusts offer a good degree of financial privacy. They can be made as private arrangements between individuals, unlike wills which undergo public probate procedures. Some information about foundations is publicly available, but there is no requirement to reveal the identities of the founder, beneficiaries, or purpose of the foundation. Trusts are even more private in that they do not generate any public information.

Which is Right for You?

Deciding between setting up a trust or a foundation depends very much on your specific circumstances and objectives. Both can be used as powerful asset protection and estate planning tools. However, offshore asset protection trusts in the Cook Islands and Nevis have been shown to provide superior levels of privacy and asset protection, so they would be the best choice if this your main priority. Foundations can provide excellent tax efficiency, and are an ideal vehicle through which to give charitable donations, transfer wealth to loved ones, or uphold a family legacy. 

Whichever you feel is right for you, it is best to consult with an expert attorney who can help you establish and structure your trust or foundation in the most cost-effective, timely, and advantageous manner. These are highly complex instruments that, when used properly with the guidance of a professional, can generate significant benefit to both you and your beneficiaries.