Trusts and estate planning
The legal structure of a trust is an agreement between a donor (or a founder) and trustees, in terms of which the donor donates property to the trustees to be administered for the benefit of beneficiaries.
The donor may be a trustee; the donor and one or more of the trustees may be beneficiaries. But the same person cannot be the donor, a trustee and the sole beneficiary. That is a sham trust and the trust property will regarded as the donor’s property.
A trust is a legal entity; the trust owns its assets and property and is liable for its debts. The donor, trustees and beneficiaries are not personally liable for the debts of a trust. The trust assets do not belong to the trustees or the beneficiaries, so they cannot be attached to pay the debts of the trustees or the beneficiaries and they do not form part of the estate of the trustees or the beneficiaries when they die.
The basic legal structure of a trust may be used for many purposes, including:
- A business trust, where the trustees manage the business and the beneficiaries receive the profits (analogous to a company’s directors and shareholders);
- An altruistic trust, where the donor donates property that is administered by the beneficiaries for the benefit of a charitable cause or group of people unrelated to the donor;
- Looking after money for a person who is not capable of doing so him/herself. This has been common with Road Accident Fund and similar compensatory payouts, where the fund creates a trust, usually with a bank as trustee, to administer the compensation paid to a beneficiary;
- A family trust, where the trust is used as an estate planning tool to manage a family’s wealth.
Business trusts have never been popular, as companies and close corporations can be used as a vehicle to operate a business with no disadvantages over a business trust.
The family trust is the most common type of trust that we come across. Typically, a grandparent is the donor, donating a nominal amount of money (say R1,000.00); the parents and a trusted third party, often the family lawyer, are the trustees; and the parents and the children (and grandchildren and greatgrandchildren, when they come along) are the beneficiaries.
Using a family trust as an estate planning tool, a family can protect the wealth that it creates over time from the financial risks that the parents might take in their businesses or other endeavours. At the same time, under the current taxation system, the family trust can be a tax efficient vehicle in which to hold the family’s wealth over generations.
As mentioned, the assets in a trust do not constitute value in the beneficiaries’ estate, so when the parents die, the wealth accumulated in the trust is not subject to estate duty. A trust’s income is presently taxed according to a conduit principle, which means that it is taxed in the hands of a beneficiary to whom it is distributed. So, the income can be spread among the beneficiaries, with a number of them each paying a small amount of tax, if any. The same principle applies to capital gains, which are profits made on the sale of capital assets, such as houses, paintings, shares etc.
There are disadvantages. Income and capital gains that are not distributed but retained in the trust and reinvested are taxed at a flat rate of 45% and 36% respectively. If your residence is held in a trust, you lose the primary residence exemption. Also, if you have accumulated significant wealth in your own name, it can be expensive to transfer assets to a trust, as the transfer of property will attract transfer duty and may trigger capital gains tax and donations tax. So, you have to be judicious and give thought as to how you are going to structure your estate planning and as to what assets you will place in the trust and what assets you will keep in your own name.
Despite the disadvantages, a trust is certainly worth considering as a tool to use when you plan your estate.