Trusts Remain Relevant for Estate Planning

When estate planning, some investors are reluctant to consider trusts due to their management complexity and the fees associated with them. However, there are circumstances where they can still be beneficial, particularly when considering the various kinds of trusts available to South Africans.

There is still good reason to use trusts in estate planning, often for reasons which are not purely financial.

When you divest your assets to a trust, you are changing ownership of the assets to the trust beneficiaries. The trustees must manage the assets in accordance with the trust deed, which forms the basis for governing the management of the trust’s assets. The trust founder (or settlor) may not treat the assets as their own.

Trusts are expensive to maintain and manage. There are trustee fees, accounting fees and tax charges. Consider the benefit of the trust relative to the costs.

South Africa has three basic kinds of trusts, each serving different purposes:

  • inter-vivos or living trusts
  • testamentary trusts
  • special trusts


Inter-vivos trusts

These trusts are set up during the founder’s lifetime. Trustees manage assets in the trust in line with the trust deed.

During your lifetime you can donate or sell assets to a trust using a loan account. If donated, the donor will pay donations tax of 20% of the value of assets transferred. If sold using a loan account, there will be a capital gains tax event and the loan will attract interest that will need to be included in the founder’s income. Setting up an inter-vivos trust and funding the trust by way of a loan or donation is therefore an expensive exercise as it involves a cost to the founder. Consider these costs relative to the benefits when deciding if a trust is the right decision.

Apart from the costs associated with setting up and maintaining a trust, you need to understand clearly that you are divesting your right to the ownership of the assets being divested of. The assets are no longer the property of the founder and can’t be still treated as such. Trustees manage assets held in trust. Although the original founder may be a beneficiary or trustee, they can no longer control how the trustees manage the assets.


There are several reasons to set up an inter-vivos trust:

1. A second marriage with children from both sides

Using a trust ensures assets are managed in line with the founder’s wishes. Often a second spouse may receive the right of use to a property and an income from the trust as set out in the trust deed.


2. Minor beneficiaries

Leaving your assets to a trust ensures that the capital is protected for the benefit of the beneficiaries to cover costs such as education, healthcare and housing.


3. Starting a business

There is a risk that if the business fails, creditors could approach the individual for debts relating to the failed business venture. Holding the assets in a trust mitigates this risk. If you start a business and the shares are held by a trust, the growth in value of the business falls outside your estate.


4. Protecting intergenerational wealth

This type of wealth will extend beyond two or more generations. A trust allows the assets bequeathed to be managed in accordance with the founder’s wishes. To ensure estate duty is not paid on the same assets, you bequeath them to a trust. The initial amount bequeathed, and any growth, will no longer form part of an estate. This circumvents assets attracting cascading estate duty. Death gives rise to a capital gains tax event, so bequeathing assets to a trust allows trustees to manage capital gains
tax as the trust does not “die”.


5. Adult heirs who can’t manage their own financial affairs

Trusts have been set up to receive the assets of adult heirs who cannot manage their own funds as a result of gambling addictions or substance abuse. More importantly, if the heir cannot manage their own funds responsibly, it is unlikely that funds they inherit will be used responsibly to support their spouse or children.

If any beneficiary or founder of a trust moves to another country, you should consider the beneficiaries’ status on the trust before the move occurs. This can have serious tax implications which can prove costly to the beneficiary.


Testamentary trusts

A testamentary trust comes into existence as a result of a clause in your will after your death. The main reason for a testamentary trust is for funds left to minors or a spouse. The will specifies the trustees of the trust and their powers. A testamentary trust usually ends when a minor reaches a specific age.


Special trusts

This is a trust set up for a beneficiary who is mentally or physically challenged and unable to provide for themselves financially. The trust ensures financial support for that individual.


 Tax and trusts

A trust has a flat income tax rate of 45% – any income earned will be taxed at 45%. Many individuals will pay income tax at a much lower rate. In addition, a trust does not qualify for any deductions such as the interest abatement and capital gains tax abatement on a primary residence. Special trusts are taxed on a sliding scale from 18% to 45%.

The capital gains rate of a trust is also high compared to that of an individual. The inclusion rate of any gain earned by a trust is 80%. This means you will pay an income tax rate of 45% and capital gains tax of 36% compared to an individual taxpayer paying income tax at a 45% marginal rate and a maximum rate of 18% for capital gains tax.

Income and capital gains can be attributed to the founder or the beneficiaries, but this can become technical and professional tax advice should be sought. This does, however, mitigate the higher taxes payable if the income or capital gains were to be taxed in the trust.

Trusts have their place when used for the right reasons. Consult your financial planner and trust expert to ascertain whether your reasons for forming a trust are sound.

INFORMATION ON ALEXANDER FORBES

Alexander Forbes is a specialised financial services group headquartered in South Africa focusing on employee benefits solutions for institutional clients, and financial well-being and retail financial solutions for individual clients, in particular employees of the Group’s institutional clients. Alexander Forbes is listed on the Johannesburg Stock Exchange (“JSE”), and its primary clients span both the private and public sector market segments, including employers, retirement, health, investment and other special purpose funds on the institutional side, and individual members and beneficiaries of these funds, as well as the wider individual market, on the retail side. The main services provided by the Group include retirement funds and asset consulting, actuarial, investment and administration services, employee risk benefits and healthcare consulting, individual financial advisory and multi-manager investment solutions. Alexander Forbes’ principal geographic focus is South Africa, where it has been operating since 1935, sub-Saharan Africa, the UK and other selected jurisdictions with employee benefits legislative frameworks similar to South Africa.

www.alexanderforbes.co.za