THE ROLE OF TRUSTS
IN ESTATE PLANNING

During a recent webinar we held for our clients, our Head of Fiduciary and Tax, Stanley Broun, tackled these and other pressing questions around trusts and estate planning. You can read a condensed version of some of the main discussion points below, or watch a recording of the webinar here.

The transfer of assets between generations is often a highly complex process, and many individuals don’t have appropriate structures in place to preserve their wealth for the next generation. What role can trusts play in global estate planning?

These days many South Africans have assets both within the country as well as offshore, and trusts offer an efficient and flexible way of ensuring your assets are consolidated, preserved, protected and managed objectively. They offer many benefits, not least of which protection against claims by creditors, and since the assets in the trust (depending on how they were transferred) won’t form part of your estate, estate duty of 20% (or even 25%) in South Africa won’t be payable on your death.

In addition, your beneficiaries won’t be faced with the delays usually associated with the deceased estate administration process, or executors’ fees of up to 4.03% on your assets. Trusts can protect against capital gains tax (CGT) arising as a result of the deemed disposal rules of effectively up to 18% on the capital gains on your growth assets on your death. They can also protect against assets being frozen on your death in your own name with no access to liquidity for your surviving family members to pay the bills.

Offshore trusts play a similar role in ensuring that assets are protected and wealth can continue to grow for the generations that come after you.

What are the most commonly used types of trust, both local and offshore?

Inter vivos trust: This is a trust established while the founder is still alive. The trust assets won’t form part of the founder’s estate for the purposes of estate duty and CGT, although the family should seek expert advice on the mechanics of transferring assets into the trust as well as the potential income tax, donations tax and estate duty consequences.

Testamentary trust: This type of trust is created in terms of your will and comes into existence at your date of death. Your assets are then transferred into the trust as a bequest after CGT and estate duty have been paid. You can specify the capital income beneficiaries in your will, as well as how you want distributions to be done.

Special trust: Special trusts are in our view the ideal vehicle to benefit individuals unable to manage their own finances – such as disabled or mentally handicapped persons, or minors. Compared to other trusts, they enjoy a host of tax benefits, but they also have their fair share of qualifying requirements as set out in the Income Tax Act. Interestingly, it may be possible to nominate a special trust as a beneficiary on a life annuity product, but this would depend on the rules of the investment house in question.

Offshore trust: Offshore trusts are often the most suitable mechanism to align your offshore asset holdings with an estate plan. They facilitate global diversification of assets in a way that allows for succession upon death, so complex issues relating to offshore inheritance tax and probate requirements can be largely avoided. Depending on the funding mechanism, in South Africa, assets held in such trusts typically won’t be considered part of an estate on death for purposes of the administration process, executors’ fees or estate duty and CGT.

Dry trust: This is an offshore trust that is established while the founder is still alive, but the dry trust – also known as a ‘passive’ or ‘freezer’ trust – remains practically dormant until date of death, when your offshore assets will be transferred into the trust, as determined in your offshore will. So, whereas in South Africa a testamentary trust comes into being only at date of death, a dry trust is set up beforehand, but only becomes fully operational once it receives the offshore assets.

Subsequent to the payment of the relevant CGT, and estate and/or inheritance taxes on death, once the assets have been transferred as a bequest to the dry trust, there will likely be no further South African income or estate taxes in the hands of the beneficiaries for as long as the assets remain owned by the trust. Read more about dry trusts here.

With people living longer, the time may come when – due to old age, an illness, stroke or dementia – you no longer have the mental capacity to manage your own estate. What role can trusts play when you can’t physically or mentally deal with your own financial affairs?

We advise our clients that once they reach a certain age, it may be a good idea to transfer at least some of their local or international assets into a South African or foreign inter vivos trust respectively – of which they are also beneficiaries – either by way of donations or a loan account (see next question). If you should become incapable of managing your own affairs, the trustees of your trust will be able to make decisions about how your funds should be spent to provide for your personal care.

It’s important to remember that if you’ve granted someone power of attorney to act on your behalf, under South African law, if you’re no longer capable of making your own decisions, the power of attorney will fall away (read more about this here). Without a trust, the alternative in such a case may be curatorship, which could be a lengthy and expensive process.

You’ve mentioned that assets can be transferred to a trust either via donation or a loan account. What is the difference?

Donating funds into a trust essentially means you’re paying estate duty ‘in advance’ (read more here). You’ll be paying donations tax, but the size of your estate on your date of death will be smaller for the purposes of estate duty. Bear in mind that donations into a trust may trigger CGT events, depending on the type of assets you transfer, but this will be very similar for donations made during your lifetime and estate duty at date of death. The main exception is that any income or gains arising in the trust will typically remain taxable in the hands of the donor during his or her lifetime.

Depending on your individual circumstances, you may wish to transfer funds to a local or offshore trust by means of a loan account, which will also have tax consequences, but won’t necessarily decrease the estate duty payable on your date of death. The tax consequences of transferring assets to a trust can be complex and can be different for loans made to local versus offshore trusts. If a loan to a local trust is not interest-bearing at the official rate, and if the rates for a loan to an offshore trust are not market-related, this can give rise to donations tax on the local interest component and income tax on the offshore interest component.

It’s important to note that where loans do carry interest at the above-mentioned rates, the interest earned will form part of your annual income tax calculation. Deciding which method of transferring assets to a trust to use could have far-reaching financial consequences and it’s therefore crucial to consult an adviser to discuss your particular situation.

What are the tax implications if the beneficiaries of your trust have moved overseas and have ceased their tax residency in South Africa?

Housing most of your wealth in a trust structure is generally regarded as ‘perfect planning’ from a South African perspective, but it may not be the best solution if any of the income and capital beneficiaries have ceased their South African tax residency. Trustees should caution against vesting income or capital gains in the hands of non-tax resident beneficiaries without understanding all the implications, which could have severe consequences for the offshore beneficiaries – who will typically also have a liability to taxation and obligations to declare such distributions to the tax authorities of the country they’re living in.

We normally advise our clients to review their trust structures – both local and offshore – on an annual basis as part of global estate planning, to determine whether they are still the most appropriate structures given potentially changing family circumstances, including different generations living in multiple jurisdictions, or whether amendments need to be made. Read about legacy planning for offshore beneficiaries here.

Why is it important to appoint an independent trustee on a South African trust?

Although not a strict legal requirement, the Master will typically not register a trust unless there is an independent trustee in office. It is in most cases better to have an independent trustee – even more so if he or she is a ‘professional trustee’, because such a person would have the necessary expertise and skills, and would be up to date with changes in legislation, court cases and tax matters applicable to trusts.

It’s important to note that trustees are responsible for ensuring that the trust’s tax affairs are in order, that the financial statements have been drawn up, that the trust is in a healthy state, and that investments are done for the benefit of the beneficiaries. An independent trustee can play a key role to ensure that the trust affairs are managed properly and above board, and can provide guidance to other trustees on more technical aspects of running the trust. Read more about this here.

Why is trustee training important?

The trustees of a family trust often don’t realise that they could be held liable if they failed in their duty to manage the trust in accordance with the stipulations of the trust deed. It’s therefore important that all trustees undergo trustee training to ensure they’re well equipped to act at all times in the best interests of the beneficiaries. Equipping the next generation with the proper tools will place them in a position to further the legacy you’ve bequeathed to them.

Does a South African resident with offshore assets need a separate offshore will?

If you have offshore assets at your time of death, foreign inheritance or estate taxes, probate issues and forced heirship rules may be applicable. We therefore recommended that in addition to your South African will, you draw up an offshore will to deal with your offshore assets. It’s imperative to have a thorough understanding of all the potential implications, however. For example, when drafting separate local and offshore wills, you’ll need to ensure that your offshore will doesn’t unintentionally revoke your other will(s) – expert advice is therefore crucial. Read more here.

Trusts – both local and offshore – still play a key role in global estate planning. However, they’re not for everyone, and there is no one-size-fits-all solution. Your personal circumstances, and therefore your estate plan, will be unique, and it’s important to seek professional advice – especially if you have assets in multiple jurisdictions. If you need any information or assistance with any aspect of estate planning, please contact Stanley Broun on +27 (0)11 778 6648 or stanleyb@privatewealth.sanlam.co.za.