What is a Trust?
The basics of a trust
A trust is an entity that will “outwit, outplay & outlast’” an individual. It will not terminate (unless decided by the trustees), therefore it can own properties and assets for generations, and pass the portfolio of assets to the next generation tax-free. A trust is the only vehicle which allows the accumulation of wealth and the transfer of assets from one generation to another without incurring costs and taxes. The growth in the estate is “pegged” upon the creation of the trust and the value will increase in the trust and not in the hands of the individual. A trust creates a separate legal entity that owns the assets outside of the individual’s personal estate, and therefore the trust assets do not form part of your personal estate for the calculation of Estate Duty. The type of trust we refer to is an inter vivos discretionary trust, a living trust that is set up while you are alive, not a testamentary trust, which is created after death.
Why do you need a trust?
A trust is an efficient and flexible way to ensure that your assets are protected and preserved. A trust is the arrangement through which control and ownership in property is by virtue of a trust instrument made over or bequethed to another person or persons (trustee/s) for the benefit of beneficiaries in accordance with the terms and conditions of the trust deed. The trustees have bare ownership (otherwise referred to as legal ownership) of trust property, not beneficial ownership.
There must be a clear separation of control from enjoyment of trust assets, otherwise SARS and the courts may label it as an alter ego trust (an extension of yourself or of your estate) and then the trust will be disregarded and the whole objective of setting up a trust in the first place will be disregarded. Trustees control the trust assets for the enjoyment of it by the beneficiaries. All trustees assume significant responsibility when accepting an appointment as a trustee. Any breach of fiduciary duties by any trustee will result in significant exposure for the trustees.
Importance of an independent trustee
The appointment of an independent trustee will mitigate this real risk of attack. An independent trustee must at all times act in favour of the trust and not any individual. A well-known court case, Land Bank of South Africa vs. JL Parker and Two Others (the Parker case) irrevocably changed the requirements for independent trustees to be appointed and placed renewed focus on the duties and responsibilities of all trustees. As a result of the Parker case, most Masters of the High Court now require an independent trustee to be appointed in addition to the trustees who are beneficiaries of the trust, and therefore will not issue Letters of Authority without at least one independent trustee being appointed. An independent trustee will be a person who is not related to the founder, the other trustees or the beneficiaries. This independent trustee does not necessarily have to be a professional person, but it must be someone who fully realises the responsibilities he/she is accepting when agreeing to act as a trustee, and is qualified in the view of the Master of the High Court to act as a trustee. The less an independent trustee is related to the other trustees, the more independent it would seem to creditors and SARS.
All trustees (independent or not) are charged with the responsibility to ensure that the trust functions properly to the greatest benefit of the beneficiaries. These responsibilities include, but are not limited to:
- ensuring compliance with the provisions of the trust deed
- ensuring compliance with all statutory requirements
- conducting of proper trustee meetings
- recording of proper minutes of all meetings and decisions by the trustees
- proper maintenance and safekeeping of minute books
In many cases, the trustees who are not independent, do not have sufficient knowledge of and experience in the proper administration of trusts. Furthermore, they might also lack expertise in utilising the vehicle of the trust in order to maximise the benefit for the beneficiaries. This expertise includes negotiating and entering into business contracts, holistic tax and succession planning, and ensuring the optimal growth of the trust assets. It is in the best interest of the trust that this person also has sufficient knowledge of the impact of statutory requirements, such as compliance with relevant tax law and the effect of changes in legislation on the trust.
Myths about Trusts
1. Trusts do not serve a purpose until you have created wealth
The truth is that the wealthy have set up their trusts before they become wealthy. The vehicle you choose to create and protect your wealth in, is an indespensable way for you to achieve your financial freedom goals. It has to be put in place before any wealth is created, as subsequent changes in the structure will cause major tax and other consequenses and you will be exposed to risk until such time as you move your assets into a trust. You will be compromised should anything happen before you have put the structures in place (death or attack from creditors) or wealth have already accumulated in your own hands by the time you believe you should transfer it into a trust.
2. Trusts have the worst tax rate
This is only partially true. Only if the trustees decide to retain all the profits and not distribute it to the beneficiaries, will the trust be taxed at the 45% tax rate on income. The conduit principle, however allows trustees to shift the tax burden from a trust to beneficiaries and therefore paying tax at the individual’s marginal tax rate, which may in many instances be lower than the trust tax rate of 45%. You can therefore legally be making use of this mechanism and achieve an even better tax efficiency than what you would have achieved in your personal capacity. This makes it possible to do tax planning from time to time.
3. Trusts are expensive
Trusts do cost money to set up, but it may be “penny wise, pound foolish”, as it may “cost” you more by not having a trust. The cost of estate duty, capital gains tax, executor’s fees and income tax can be very expensive, if you do not take advantage of setting up a trust. A correctly structured trust is also a lot more economical and cost effective than running a company or close corporation.
4. You lose control over your assets if it is owned by a trust
Trustees control the affairs of the trust, so you will have to pay careful attention when you select trustees. There are ways to structure a trust so that you do not feel that you are giving up full control over your assets – you can be the founder, one of the trustees and a beneficiary of the trust and still satisfy SARS, other creditors and the Master of the High Court of the legitimacy and lawfulness of the trust. An independent trustee typically gives comfort to SARS, other creditors and the Master of the High Court, whilst assisting you to not lose control over your assets, through the way the trust is set up.
5. SARS are investigating trusts
Trusts have been used for almost a thousand years internationally. Trusts will be investigated by SARS if they are brutally misused and mismanaged. If a trust is correctly structured and administered in accordance with the trust deed, the Trust Property Control Act, 57 of 1988 that governs trusts in South Africa, and other relevant laws, SARS will have no leg to stand on.
Why a trust is the most comprehensive estate planning vehicle in the world
1. A trust provides total continuity
If individuals have not structured and properly planned their assets, cash, property portfolio, insurance portfolio, business interests correctly, all their assets may have to be liquidated to compensate for all taxes and outstanding debt upon death. This could be potentially detrimental to your family and their financial well being. This could be avoided through proper planning and structuring.
2. Taxes and costs of more than 30% can be saved upon your death
If you do not have a trust, more than a 1/3 of your life assets will go to SARS when you die, and that is based on assets that you have acquired with money you paid tax on while you were alive.
A trust ensures the following:
- No Estate Duty (20% of the Estate below R 30 million, and 25% of the Estate above R 30 million) as the trust will continue to persist after death.
- No Capital Gains Tax on growth assets. Death is deemed as a disposal and will trigger if you hold these assets in your own name upon death.
- No Executor’s fees (at 4.025% of the Gross Estate). This is an unnecessary and avoidable tax. Executor fees are calculated on the gross value of an estate and deducted before any other expenses, therefore the executor can receive up to 10% of a net estate.
3. No cost on death
No transfer costs and bond cancellation costs on immovable property and costs related to other assets, which are already registered in or held by the trust (as ownership does not transfer to anyone after death).
4.Your minors are protected
In South African Law, a minor in general cannot inherit money (and it is not wise to leave immovable property to a minor). Therefore upon death of the parent (or other person who the child inherits from) normally the assets held in their personal name upon death are liquidated and the proceeds invested in the Guardian Fund, with limited access thereto until the minor turns eighteen. It therefore makes sense to pro-actively structure assets in a trust as part of your estate planning where minors may inherit.
Assets are also protected against spendthrift children, who will not be able to reduce the assets to zero.
5. No estate freezing
Bank accounts and cash reserves of a trust will not be frozen during the winding up of the estate, which can take up to two years or longer in the case of a deceased estate. A trust will ensure rapid access to capital and income after death.
6. Multi-ownership of assets
Some assets cannot be divided (e.g. businesses, farms or other property). By placing these types of assets in trust, the heirs can be the beneficiaries of the income generated by the assets. The heirs are also protected from one anothers creditors and potential claims by spouses upon divorce or potential claims of creditors upon sequestration of an heir.
7. Confidentiality
A will and the Liquidation and Distribution Account in a deceased estate become a public document on death. A trust does not form part of an estate, and therefore the list of assets held in a trust remain confidential.
Is your life cover structured in your family trust?
A strange fact is that more than 95% of clients have their Life Cover in their private capacity (individual names). They do not enjoy any tax benefits and have very little protection (in many cases none whatsoever!). Spouses are usually nominated as the beneficiary.
A 'short and sweet' benefits list of a trust-owned life policy:
- No executor's fees
- Continuity
- Protection
- Tax benefits
In summary, if structured correctly and administered properly, a trust remains the most comprehensive estate planning vehicle in the world for the following reasons:
- It provides total continuity
- It ensures liquidity – no asset freezing upon death
- Taxes and costs of over 30% can be saved upon death, which often requires the executor to sell assets to pay these taxes and costs
- It allows multi-ownership of assets with no disruption upon death
- It ensures confidentiality, unlike a will and liquidation and distribution account which becomes public documents upon death
