Financial Planning

Estate Planning and Trusts

A question that is often debated in the current financial planning environment is whether trusts still have a role to play in estate planning. The simple answer is yes, but it does need to be qualified. There have been many changes in terms of our tax legislation, and some court cases which impact on the manner in which trusts need to be administered and their cost-effectiveness. The days where a trust was essential in every good estate plan have passed.

Testamentary trusts

Without doubt, testamentary trusts remain an invaluable tool in estate planning, in particular where there are minor children involved. The estate will attract executor’s fees and potentially estate duty and capital gains tax, with the inheritance possibly having to be reduced to cash and be paid into the Guardian’s Fund; nevertheless the benefits of a trust far outweigh the taxes that may be incurred. A proper financial plan will take these taxes and costs into account to ensure that there is sufficient liquidity in the estate to settle them, without any risk to the assets in the estate or the capital that is to provide an income for the benefit of the minor children (or the spouse or adult dependents who lack the financial savvy to deal with an inheritance effectively).

Inter-vivos trusts

Traditionally, the trend has been to move growth assets into an inter-vivos trust, thereby capping the value of the assets at the value they were when transferred into the trust. When the planner dies, the growth on the assets does not fall into his/her estate, and therefore no estate duty or capital gains tax (CGT) will apply. As the assets are not included in his/her estate , there are also no executor’s fees. This means the planner could potentially save 3,5% on executor’s fees (plus VAT, if applicable), 20% on estate duty and capital gains tax on 25% of the gain, taxed at the planner’s marginal rate of tax. This could amount to a considerable saving.

If the asset is sold to the trust (usually, an interest-free loan is created in favour of the planner), then to the extent that the loan has not been settled, this loan will be an asset in the planner’s estate and will attract executor’s fees and may attract estate duty and possibly even CGT (in the hands of the trust), depending how it is dealt with. The value of the loan account should technically be less (considerably less, if it is a true growth asset that is held by the trust for a reasonable period) than the value of the asset, so the planner has effectively reduced the taxes and costs incurred in his/her estate.

It seems logical, therefore, that a trust is an effective estate planning tool. However, before you decide to apply this wholesale to all your clients, consider the following points:

  • On transferring the assets to the trust, the planner effectively relinquishes his ownership and control over them. If s/he does not do so, and continues to treat the trust assets as his/her own, then for all intents and purposes s/he has simply created a “sham” trust, which SARS (and her/his creditors) will look through, and all the taxes may be levied in the event of her/his death, as if s/he had actually held them in her/his own name. Relinquishing ownership and control over one’s assets is a step that must be carefully considered, to establish if it is appropriate or not and whether the planner can actually live with this state of affairs.
  • Tax charged in the trust can be at a higher rate than in the individual’s capacity. This is a very broad topic, so we will touch on it only briefly by stating that all income retained by the trust will be taxed at a flat rate of 40%, and all capital gains made and retained by the trust will be taxed at an effective rate of 20% (50% of the gain taxed at 40%).
  • The cost of transferring assets into a trust can be high as well; for example, the cost of establishing the trust, the CGT incurred in the planner’s hands when s/he disposes of her/his assets to the trust, transfer duty on transferring immovable property from the planner to the trust, donations tax, if s/he donates the assets to the trust instead of selling them to the trust, etc.
  • It is essential to have a third-party, arms length trustee, with proper record keeping of all meetings, showing that this trustee does not merely rubber stump the decisions of the planner, but actually exercises his/her discretion in terms of what is beneficial to the beneficiaries of the trust. This trustee will normally charge a fee for his/her professional services, and rightly so. Remember that, for example, trustees are personally liable to SARS if the trust does not account for its taxes correctly, so the independent trustee could potentially be exposing him/herself to risk. This fee can amount to a sizeable sum of money over time.

Taking all the above factors into account, if the sole reason for establishing the trust is to save on taxes on death, then as the adviser you owe it to your client to weigh up the cost of creating liquidity, through life insurance, for example, to pay these taxes, versus the other costs, such as the independent trustee’s fee , and establish which is the simplest and most cost-effective manner of dealing with the “taxes on death” problem – the trust or simply effecting life cover to pay the taxes. Remember, all assets bequeathed to a spouse will qualify for the section 4(q) deduction as well as a CGT rollover. From next year, on the death of the second dying spouse the section 4A abatement may accumulate and he or she could qualify for up to R7 million estate duty free, depending on how much of the abatement was used by the first dying spouse.

If the growth asset is something that will never be realised, but kept in the family for generations to come, such as a game farm, or holiday home at the coast, then despite what is stated above, transferring it to a trust may still make good financial planning sense. As the financial adviser, you need to establish the true need or reason why the asset is to be transferred to an inter vivos trust (it is very seldom to save estate duty only!) and advise your clients accordingly.

It is also important to note that trusts remain a focus area for SARS due to the utilisation of trusts to avoid tax. Initiatives in this regard will include greater cooperation with the Master’s office to register trusts and identify risk cases as well as the allocation of more specially trained auditors.

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