Which type of trust to choose - A testamentary trust or a living trust?

When people seek estate planning advise, they may be advised to consider a trust. However, people are advised to avoid the hassle of having a trust whilst they are alive (an inter vivos trust) and to rather have a trust registered upon their death (a testamentary trust). Although advisors may advise their clients that a similar effect is achieved, the effect of the two types of trust are vastly different and one needs to understand these differences before a decision is made.

A trust may be used to hold and protect personal or business assets. This is especially beneficial in the event of subsequent liquidation, sequestration or divorce. Trusts may also be used to hold shares in businesses so as to ensure the continuity of ownership of assets. Setting up a Special Trust for a mentally disabled or incapacitated person allows for the safe custody of assets, while at the same time benefitting from lenient tax treatment from an Income Tax and Capital Gains Tax perspective. Trusts can also be used to avoid the need to place a person under curatorship. This is especially true for people who suffer from Alzheimer's Disease or simple senile dementia. If you have created a trust during your lifetime and become afflicted by one of these dreadful conditions, your financial affairs would continue as before, with persons that you entrusted as trustees of the trust. 

But then you may be a single parent, who is merely a salaried worker, who is only worried about who will look after your child’s financial affairs when you are no longer around.

Trusts also have an important role to play in estate planning and will affect your decision in terms of how much risk and investment life assurance you require. This is because setting up a trust will affect how much Estate Duty and Capital Gains Tax your estate will pay and the provision you make for your dependants after your death.

Inter vivos trusts

An inter-vivos trust is established during a person’s lifetime in order to manage certain assets or investments, and support beneficiaries such as family members, during his/her lifetime and after his/her death. The objective of this type of trust is usually to protect assets and to provide an income for the beneficiaries. It is also used to transfer assets to the capital beneficiaries (i.e. the beneficiaries who may receive trust assets and profit on the sale of trust assets) during both the lifetime, and upon the termination of the trust.

Inter-vivos trusts are ideal for keeping growth assets (shares, properties and alternative investments) out of your estate and are superb mediums to limit Estate Duty and to protect assets from generation to generation.

These trusts can be structured as either vested or discretionary inter-vivos trusts. In a discretionary trust, the trustees have the right to decide how much income (or capital) to award to each beneficiary, whereas in a vested trust, the beneficiaries are the rightful owners of the assets and therefore have a right to it, but the administration is taken care of by trustees, until for example, when a child turns 25. Upon the death of the beneficiary, these assets will be included in his/her estate. The beneficiaries will also be liable for all taxes resulting from the assets. Complications can arise in vested trusts in the event of a beneficiary’s insolvency or death. A discretionary trust is extremely flexible and can be used to take into account any family, financial and legislative circumstances. This means that the trustees can manage the trust’s assets in the best interests of the beneficiaries, at any particular time, by taking into account all the relevant factors at that time. This flexibility caters for uncertainties such as divorce, insolvency, increase in family size or fortunes, and changes to tax legislation, provided the beneficiaries are defined, and the trust deed is drafted in such a way as to anticipate these uncertainties.

Testamentary trusts

Testamentary trusts come into existence after the death of the founder. They are commonly known as “will trusts” and, as such, are created in terms of the will of a deceased person. The implication is that during your life, your assets will not be protected, and upon your death taxes will be paid first on the value of the estate, before it is transferred into the trust.

Testamentary trusts are especially suited to the protection of the interests of minors (because minor children cannot, in terms of South African law, inherit anything) and other dependents who are unable to take care of their own affairs, after the death of the person who supported them, and such a person was a normal salaried worker without too many assets. In the absence of a trust (testamentary or inter vivos), assets from the deceased estate left to minor children are sold, typically placed into the Guardian’s Fund and the money is paid to them when they reach adulthood. The child’s guardian does not necessarily have to be a trustee; in fact, it is often a good check and balance to have a separate, independent person - who is financially astute - as a trustee.

Testamentary trusts are created at the winding up of a deceased estate, following a specific stipulation in a person’s will that a trust must be set up. Such a stipulation in the will serves the same purpose as a trust deed. The terms of a testamentary trust are typically not as detailed as with an inter-vivos trust, which often cause problems with its execution. Sometimes a full trust deed is attached to a will, instead of incorporating the usually shorter provisions of a testamentary trust in the body of the will. This serves to provide additional comfort and assurance that the testator’s wishes will be honoured.

If for any reason the will is invalid, the trust will not come into effect. The Master of the High Court has the power to declare this type of trust invalid, unlike an inter-vivos trust, where the Master of the High Court has no such power. This may have grave repercussions for your loved ones.

Generally, the terms of a will trust cannot be amended, but the Trust Property Control Act does give the Court certain powers to amend this type of trust instrument. This makes a testamentary trust inflexible.

Conclusion

It is clear from the above that you firstly need to establish your goals, both financial and personal, and understand your personal financial risk, before you decide which type of trust will best suite your needs. Your timing of setting up a trust will have vastly different implications, which you need to understand before you are convinced by your advisor.