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Trusts for financial and estate planning

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Trusts can form a valuable part of your financial plan, but they can be complex and are more suited to wealth already accrued, and to protect family legacies. They are used to transfer assets out of your personal estate and control, for the benefit of others, either during or after your lifetime.

Trusts are separate entities created through a legal relationship between an individual (the founder or settlor) and a group of individuals (the trustees) to manage assets on behalf of other individuals (beneficiaries).

Basic elements of a Trust

Basic Elements of Trust for Estate Planning

The Trust Property Control Act, Income Tax Act and Common Law primarily govern trusts.

The Trust Property Control Act provides that trustees are required to manage Trust assets in the best interests of the beneficiaries, with strict adherence to the Trust Deed.

Different types of Trusts

There are numerous types of Trusts for different purposes, which can firstly be defined by when they are created, namely:

  • While the founder is still alive: Living Trusts (Inter-vivos Trust),
  • Or on the death of the founder: Testamentary Trusts (Trust mortis causa)

The types of either Living or Testamentary Trusts will further be dependent on how much power and authority the Trust Deed will give the trustees:

  • In Vested Trusts, the beneficiaries are the owners of the Trust’s assets and have a vested right to the assets or income generated within the Trust.
  • In Discretionary Trusts, the trustees manage the assets and income at their discretion.
  • Or alternatively, there can be a hybrid of the two.

Trusts can be further categorised based on their purpose. They may be created for trading, for charitable organisations, to care for the disabled (Special Trusts), or to protect assets (Family and Testamentary Trusts).

Main Benefits

  • Assets held within a Trust are managed on behalf of beneficiaries who may otherwise not be able to manage these assets themselves.
  • Trusts can exist in perpetuity, potentially over generations.
  • Trust assets are not subject to executor’s fees and estate duty.
  • Trusts provide creditor protection in the event of a beneficiary’s insolvency.

Main Shortfalls

  • The Founder or donor to the Trust hands over control of the assets.
  • Trusts will have initial and annual running costs applied, which can be expensive for smaller Trusts.
  • Trusts cannot invest directly offshore and thus would need to make use of complicated asset swapping and feeder funds to gain offshore exposure.
  • Trusts are subject to high tax rates: 45% income tax rate, with tax on capital gains at a rate of 36% versus a maximum of 18% for individuals.
    • However, if income or capital gains are distributed to beneficiaries instead of retained within the Trust, these can be taxed at individual tax rates and not Trust tax rates. This is the conduit principle and should be understood in conjunction with Section 7 and Section 25B of the Income Tax Act.
    • The higher tax rates do not apply to Special Trusts.

Setting up a Trust

The basic requirements for a Trust include a valid Trust Deed, a copy of the Will (for a Testamentary Trust) and identification documents of the parties to the Trust. Another often overlooked key requirement for a legal Trust is a minimum of three trustees where at least one is an unrelated and independent individual – preferably, a qualified professional (e.g., an attorney, auditor, or accountant).

Where a Trust does not have an independent trustee, the Master of the High Court may consider the Trust assets to be in control of the founder or a family member. Section 3(3)(d) of the Estate Duty Act provides that the Master of the High Court can include the assets of the Trust in the estate of the deceased, if the Master feels that the assets were under their control. This is an important factor to take into consideration as it can have severe financial consequences to the heirs of your estate.

Transferring assets to a Trust & Section 7C

Assets can be transferred to a Trust on death in accordance with a Will, a Trust can buy assets at market value, or an asset can be donated, triggering donations tax upfront of 20% to 25%. Alternatively, you can sell an asset to a Trust using a low or an interest-free loan.

Since its introduction in March 2017, Section 7C of the Income Tax Act provides that any interest below market-related interest rate charged to a Trust, is effectively, an annual donation by the settlor (the loaner) and is subject to donations tax.

As an example, an individual transfers a R 20m investment to his Family Trust. The Family Trust will create an interest-free loan of R 20m to pay the individual for the investment.

The individual will forgo interest of R 1 050 000 on the loan each year. At the time of writing the prescribed interest rate is 5.25% (which is the repo rate + 1%). By virtue of Section 7C, the R 1 050 000 interest not taken is the individual’s annual donation to the Trust and will be subject to donations tax (in this example donations tax will be R 210 000). The donations tax and value of the loan account can be decreased by means of loan repayments back to the individual by the Trust.

Section 7C will not apply in some cases, including disability (Special) Trusts, in specific Vested Trusts, and Charitable Trusts to name a few.

Estate Pegging (securing) – A method to decrease death taxes

As the value of property in your and your heirs’ estates increases over time, (e.g. farmland, business shareholdings), so too will the estate duty payable on death. Estate Pegging is a strategy whereby using a Trust to hold your assets will cap your estate duty, with any further growth no longer being subject to estate duty. This allows your heirs to enjoy valuable assets without being subject to large estate taxes on death.

Estate Pegging should be considered in the following case:

  1. You have valuable assets in your estate,
  2. You feel you have a medium to long life expectancy,
  3. You feel comfortable with relinquishing control of assets to trustees, and
  4. You are comfortable with the annual donations tax applicable in accordance with Section 7C (part of annual Trust running costs)

The chart below provides a comparison between the potential total costs (taxes, duties, and fees) that will be incurred in holding assets as an individual versus a Trust on death:

Estate Pegging ComparisonIn the illustration above, we have assumed a R20m investment asset increasing in value by 8% per annum.

The chart shows that transferring assets to a Trust can reduce the value of assets that become taxable in one’s estate. In the case of the example above, transferring an investment of R20m to the Family Trust resulted in a saving of R2m should the individual pass away after 10 years.

Speak to a financial professional

Trusts and Estate Planning are both a specialised field which requires qualified advice and guidance. Get in contact to find out if and how a Trust can add value to your financial plan.

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