Using a trust to create intergenerational wealth

intergenerational wealthMost parents want their children to be financially secure and to live better lives than they were able to ‒ lives without financial stress. Parents also want to be able to leave their children a financial legacy that will provide for intergenerational wealth. This especially true for the many South Africans who were prevented from creating valuable intergenerational wealth due to apartheid.

Godfrey Mlaba is one such parent, who has an ambitious goal. He wants to build up his wealth in such a way that it could be passed down to his three sons (currently aged 18, 15 and 8) and then onwards, from generation to generation. His inspiration is mega-wealthy families such as the Rockefellers and Gettys.

“I have started as the sacrificial lamb and am using some of the available savings vehicles such as a tax-free savings account for the whole family, an equity portfolio, as well as a small business, to amass the wealth.”

His target is to accumulate one billion rand in his lifetime jointly with his boys, and house the wealth in a family foundation which will continue to support future generations with a maximum draw-down of 4% so that the money never runs out.

This is a very tall order and R1 billion is not easy to achieve, but whether you are aiming at leaving a family legacy of R1 million, R100 million or R1 billion, there are some basic principles to follow.

Setting up a trust

Godfrey would need to set up a trust to house the family wealth. Trusts are only efficient if you are planning on leaving the assets in the trust for future generations due to the high investment tax paid by trusts. If you plan on selling the assets within the trust for your own benefit, during your lifetime, then it is not necessarily a good idea to use a trust. However, in Godfrey’s situation a trust could be a suitable vehicle, although he should get advice first.

Alida Brink, Fiduciary Specialist at Old Mutual Wealth Fiduciary says a trust can be established during one’s lifetime (an inter vivos trust) or a trust can be set up in terms of a person’s will on death (a testamentary or will trust). There is no minimum amount prescribed by law necessary to set up a trust.

Brink says if the trust is set up at your death, your will must make provision for the setting up of this trust and your last will and testament will also be the ‘trust deed’. Your wealth can then be transferred to the Will Trust from your estate.

If you set up the trust during your lifetime, the trust needs to be registered at the Masters’ Office in the region where the assets (or the majority of assets) will be held.

Something Godfrey needs to keep in mind is that you can only donate R100 000 a year to the trust without incurring donations tax. So, while during their lifetimes Godfrey and his sons can each donate R100 000, this means the maximum that can be transferred into the trust would be R400 000 a year. This would certainly not be enough to reach his R1bn mark. There is an option to create a loan account but interest (currently 8%) has to be charged to the trust in order to comply with the new section 7 C of the Income Tax.

Financial planner Craig Gradidge says that Godfrey could only achieve a goal of R1 billion in his lifetime through having his own business and this business should be owned by the trust from the beginning. In this way, the capital in the business grows within the trust.

Gradidge says Godfrey also needs to ensure that he is adequately insured from the start and the proceeds of such a life insurance policy can be paid to the Trust. “This will ensure that his legacy lives on even if he does not live to see it come to fruition. This would mean allocating some of the funds intended for investment to suitable life, disability and/or dread disease cover,” says Gradidge.

Godfrey would need to get good advice when setting up the trust deed as this would prescribe the type of assets that the trust may hold. Brink says it is important to note that a South African Trust cannot hold offshore assets. Gradidge adds that a trust cannot own a tax-free savings account so those would have to remain outside the trust.

A trust also has onerous administration requirements and must have an independent trustee. Brink says it is usually advised that one should appoint a trust company/auditor/lawyer as an independent trustee to assist with the legal and administration requirements, and this comes at additional costs.

What would it take to reach R1 billion in your lifetime?

Reaching a goal of R1 billion in your lifetime would be impossible to achieve through saving a portion of your salary. You would have to save around R665 000 a month over the next 20 years!

Financial Planner Frank Magwegwe says setting a goal is one of the key pillars of good money management; another key pillar is uncovering a “money mindset”. These are beliefs and attitudes about money that influence our money behaviour. Magwegwe gives an example of a money belief that Godfrey might need to confront, which is: ‘the only way to earn an income is through being an employee’. Mathematically, it is impossible to reach his goal by being an employee unless he wins a huge lotto jackpot and invests the proceeds aggressively.

“As a financial planner, I would go beyond the numbers and explore the fact that he would need to start a business that would have to be hugely successful to achieve the goal. The bottom line is that clients with such goals force us as financial planners to go beyond budgets, insurance, taxes, and investment returns ‒ and partner people in achieving their life goals.”

Craig Gradidge says anyone looking to achieve significant wealth must take some risks to achieve their goals by investing in growth assets such as equities, listed property, offshore, private equity, as well as having a direct stake in a few businesses and a property portfolio.

“He will need to have a combination of such assets depending on how much he is able to invest in the Trust. He will certainly need a bit of luck along the way as well,” says Gradidge who adds that Godfrey will need to consider taking a bet on some promising small-cap shares that have huge potential. For example, Capitec was trading at R2 just over 15 years ago and is now trading at R715. That means a R10 000 investment would be worth R3.5 million today. Gradidge says Godfrey could consider private equity funds which have shown some good long-term returns in South Africa and around the world, as well as a venture capital portfolio via S12J funds, which offers some tax relief.

Leaving a legacy from your salary

Even if you do not aim to start your own business, you can leave a family legacy by starting to save early. If over a 40-year working career you saved 10% of your income each month towards your legacy, with a good investment growth rate of 5% above inflation, you could achieve 12 times your annual income. For example, if your annual income was R500 000, then you could possibly leave around R7.2 million (in today’s value) to your children simply through saving and investing.

This article first appeared in City Press.

Related: