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When is a trust appropriate?

Jan 10, 2024

When we think of intergenerational wealth, we often think of trusts and the proverbial trust-fund baby.

When is a trust appropriate?While trusts can be a great way to house intergenerational wealth, over the last ten years there have been significant changes to laws that affect the way trusts are administered and taxed.

This has made the administration of trusts more onerous and expensive, and less tax efficient. However, there is still a place for trusts, as long as they are used for the correct purposes.

According to Tanya Lochner, fiduciary expert at Gradidge Mahura Investments, there are three main reasons for using a trust:

  • Protection: A trust can be used to protect assets – this could include the case of someone with special needs like dementia or drug addiction. It can also be used to protect assets from creditors including divorce claims.
  • Wealth generation: A trust can house assets for future generations without transferring ownership and the consequential tax implications. This also includes protecting assets for the benefit of future generations.
  • Tax efficiency: While the tax benefits of trusts have been reduced, it can save on death costs, but there may be other tax implications you need to be aware of.

Lochner says when it comes to forming a trust you need to consider what type of assets are appropriate.

These should be long-term growth assets such as property and investments and even life insurance polices – but a short-term depreciating asset such as a car would not be an appropriate asset to include.

There are two ways to set up a trust:

  • Inter vivos trust: This is created during your lifetime, and assets can be transferred into the trust. This is usually done via a loan account or donation.
  • Testamentary trust: This is a trust that is stipulated in your will and only comes into effect on your death. At this point the assets would be transferred into the trust. This is mostly used by parents with minor children.

Lochner says a testamentary trust is for shorter-term needs and would not typically be used where there are longer-term goals like inter-generational wealth creation. The trust’s terms and conditions sit in the will and cannot be changed once the founder dies.

However, an inter vivos trust is a “living trust” and the trust deed can be altered when appropriate, such as when tax laws change, provided the trust deed makes provision for it.

Disadvantages of a trust

Once you transfer assets into a trust you lose ownership and largely control over that asset, explains Mariska Redelinghuys, Legal Specialist: Advice, PSG Wealth.

“It becomes in essence the property of trustees,” says Redelinghuys who explains that the Masters Office now requires that if all trustees are related to each other, an independent trustee must be appointed. This must be someone who is not family and understands the job and responsibilities of a trustee and can assist the family on discharging duties.

Due to increased regulation, trusts have become more expensive to administer, as trustees carry the risk and responsibility of the assets they administer on behalf of the trustees. For example, failure to maintain a register of beneficial ownership could result in a fine of up to R10 million or imprisonment for a maximum of five years.

Another important factor to consider is how assets are transferred into trusts. As Lochner explains, you cannot just transfer assets in – they would have to be either donated or sold to the trust, resulting in a loan account.

A donation of more than R100 000 per annum per individual would attract donations tax of 20%. In the case of a loan account, where the trust is required to pay for the assets, Section 7c of the Income Tax Act requires market-related interest rates to be charged on loan accounts, treating foregone interest as a deemed donation.

However, you could bequeath the assets to the trust on your death – that removes the need for a loan account and there would also be no transfer duty in the case of fixed property. The first R3.5 million of your estate can be bequeathed to a trust without paying estate duty.

All of these factors must be discussed with a tax expert so that you fully understand the implications.

There are also the costs of administration that need to be considered. While trust fees are not regulated, most fiduciary companies will charge around 1.5% of the value of the assets to manage the trust, and a further 6% on the income.

However, there is usually a fixed fee, and this can range from R10 000 a year to R18 000 a year, depending on how complex the trust is. While you can always negotiate on fees, for estates worth less than R1 million, a single trust may not be viable.

Cost-effective options for trusts

Beneficiary funds and umbrella trusts can provide cost-effective protection for both minor children or elderly parents who may be unable to manage their finances.

As David Hurford of Fairhead Benefit Services explains, unlike other trusts where a trust deed needs to be set up for each child, an umbrella trust can save you money because the fund usually sets up one trust deed for all the beneficiaries of the entire fund. Individual trust accounts are, however, opened for each child.

The trustees would work with the guardian and child to ensure expenses are covered. They would normally pay school fees directly, and provide an income for the guardian to use to cover the day-to-day needs ot the child.

A good trustee would ensure that the funds are used for the care of the child, and in some cases a lump sum may still be available when the child turns 18.

The trustee would provide the child with financial education to ensure that when any funds become due, the child is able to manage them properly.

“We have many cases where the child turns 18 and asks us to keep the funds in the trust to protect them from family pressure,” says Hurford.

Hurford says that unlike single trusts, there is no fixed fee and they charge between 1.5% to 2% of the assets under administration. For example, on an estate of R300 000, the fee would be between R4 500 and R6 000 a year.

A beneficiary fund is linked to your employer benefits. This can house the proceeds of your retirement fund and group life cover. If you are a single parent or concerned about protecting your child’s assets, you could nominate a beneficiary fund to be used for the child’s portion of your retirement fund. You could select a beneficiary fund as the recipient of the group life cover. For assets or life cover outside of your company benefits, an umbrella trust could be used.

Related:

This article first appeared in City Press.

1 Comment

  1. Very informative! Thank you for great job Maya.

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Maya Fisher-French author of Money Questions Answered

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