Trusts can enable you to rule from the grave, but you need to be very careful how you structure them.
In recent years trusts have become the buzzword in estate planning. Trusts can be used to protect your assets in various circumstances, but they can be fraught with difficulties and, if used merely to reduce estate duty liabilities, could prove to be counterproductive.
Trusts have become a major target of government because taxpayers have used them to avoid paying taxes. On the tax books to discourage the use of trusts is:
- A punitive 10 percent transfer duty payable by trusts on the transfer of property into a trust.
- A punitive rate of capital gains tax (CGT) on any gains made on assets disposed of by a trust. Trusts are taxed on 50 percent of a capital gain, as opposed to 25 percent of a capital gain made on assets disposed of by an individual. Also exemptions that apply to an individual do not apply to trusts. This includes the exemption of the first R10 000 in capital gains each year (R50 000 in the year of death) and the first R1 million of a capital gain (profit) on your primary residence. If your primary residence is held in a trust, you will pay CGT on the entire gain on disposal.
CGT exceptions apply only to a testamentary trust established for minor children, and a special trust, which is established for incapacitated dependants, who are unable to care for themselves. The income in these trusts is taxed at the same rates as those for individuals and only 25 percent of a capital gain in a trust for an incapacitated person is subject to CGT.
Trust structures
The founding document is the trust deed, which needs to be registered with the Master of the Supreme Court and with the South African Revenue Service (SARS). There are three parties to a trust. These are:
- The settlor. The person who makes the initial settlement (in other words, provides the initial amount of money) to get the trust going is called a settlor. The settlor is also called the donor or the founder. You do not have to be the settlor to provide assets to a trust.
- The trustees. The trust is administered by trustees appointed in the trust deed. If SARS feels you have not given the assets to a trust and you still fully control the assets, it will tax you as if the assets are still in your hands. To avoid this, you should have at least three trustees, but you need to be careful in selecting them, because if a relationship with a trustee goes sour, you may lose control of how the assets of the trust are administered. It is generally accepted that you should have three trustees - the estate planner (yourself), another family member (for example, your spouse), and an independent third party, such as a lawyer, who has the relevant expertise .
- The beneficiaries. These are people who are entitled to benefit from the trust administered by the trustees in terms of the trust deed.
Types of trusts
There are two basic types of trusts: testamentary trusts and intervivos (or living) trusts. There are, however, many complex subdivisions, particularly of intervivos trusts.
Testamentary (will) trusts
A testamentary, or will, trust comes into being on the death of the owner of an estate. The founding document of the trust is contained in the will of the person who has died. The trust is administered by trustees who are appointed in terms of the will. Beneficiaries of trusts may be both capital and/or income beneficiaries. Income beneficiaries receive income generated from capital held in the trust, but have no access to the capital.
The rationale of a testamentary trust is that it allows for better management and control of assets, as well as the protection of the beneficiaries of the assets (for example, where there are minor children). The trust can be set up in such a way that it will dissolve at a particular time, for example when the children reach the age of 21.
A testamentary trust can also be set up in terms of a joint and survivorship will with the trust only coming into effect when the last person dies. This, for example, gives a surviving spouse the right to the assets without interference until he or she dies.
Setting up a testamentary trust will not save your estate any estate duty because the assets are in your hands when you die and only transfer to the trust after your death.
The administrators of a trust need not be the same people as the executors of your estate.
To protect the interests of children, a husband and wife should draw up wills that ensure the testamentary trust comes into being only after the last one of them has died.
Testamentary trusts established for minor children or for incapacitated dependants are treated with compassion by the tax authorities in that they are subject to the ordinary tax rates that apply to individuals, but without rebates.
Intervivos (or living) trusts
An intervivos trust is established during your lifetime. There are both advantages as well as disadvantages to establishing an intervivos trust. The advantages include:
- Estate planning. The primary advantage of a living trust is that it allows for proper management and control of your assets after you die. In other words, it makes it possible for you to rule from the grave.
- The freezing of value. The growth in the assets will occur in the trust, and not in your own estate, limiting the net value of your estate. In other words, you will limit the amount of estate duty you pay, as the assets will be held by the trust and not by you.
- Tax planning. This advantage should be secondary and seen as a bonus - not as the primary motive to set up such a trust. There are many provisions in the Income Tax Act that will deem income to be taxed in your hands if the taxman believes that you are evading tax.
- Preservation of assets after death. Living trusts allow for the ongoing management of your assets, including contractual arrangements. This is particularly useful in a business arrangement where value could be lost by selling off a business share.
- Protection of assets from creditors. Your personal liability is limited to the assets in your name. Your creditors cannot access the assets in your trust, unless it was set up with the intention to defraud creditors.
- Assets are protected against spendthrift children, who will not be able to go on a spending spree and reduce the assets to nil.
- Protection of a vulnerable spouse and minor and/or vulnerable children, particularly if a child is incapacitated in some manner.
- Assuring rapid access to income and capital after your death. Payment to beneficiaries can be delayed for up to a year in the winding up of your estate.
- Multi-ownership of assets. It is not easy to divide some assets, such as a business, a farm or other property, between heirs. By placing the asset in a trust, it can be held intact, while your heirs can be the beneficiaries to the income generated by the asset.
- Confidentiality. On your death your will becomes a public document. However, because a trust does not become part of your estate, the assets held in the trust remain confidential.
- Cost saving. The assets in the trust are not subject to any of the fees or costs of winding up an estate, but there can be significant costs in the ongoing administration of a trust.
Disadvantages of a living trust:
- Punitive tax rates on all but testamentary trusts for minor children and people who are incapacitated and unable to earn a living.
- Perceived and actual loss of control. You no longer have total control of your assets. Your protection lies in the wording of the trust deed. A trust created under one set of conditions can become a monster under other conditions, say following a divorce when the spouse is a trustee.
- Costs. There are a number of costs involved in having a trust. These include:
- An initial fee of between R3 500 and R10 000, plus VAT, for setting up the trust.
- Registration costs (R104).
- Administration fees of between one and two percent of the value of the assets a year, if you appoint a professional administrator/trustee.
- Punitive tax rates and possible future changes in tax laws.
- A trust is an entity, which is registered and can be accessed by the authorities. It is not a place to hide money.
- Bad choice of trustees. If trustees are rival heirs or beneficiaries, this can create problems. This is why you need an independent party as a trustee.
Placing your assets in an intervivos trust
Assets can be transferred to an intervivos trust in a number of ways. These include:
- The outright sale, where a trust buys the assets at market value.
- A donation from you to the trust, but donations are subject to tax if they exceed R30 000 a year.
- The assets can be sold to the trust with either an interest-free loan or an interest-paid loan. This is the most common method. The assets become a possession of the trust. In return you have a claim against the trust in the form of a loan account. In other words, say you had assets valued at R800 000 that you transferred to an intervivos trust, the trust would then owe you R800 000. The loan can be reduced by you and your spouse each donating R30 000 a year to the trust (R60 000 a year in total).
Part 37:
Short-term insurance