Financial Planning

Trusts and Financial Planning

We received answers from Tony Barrett of Barnard Jacobs Mellet, Berrie Botha of Sanlam, Scott Field of Fedgroup, Willie Fourie of PSG Konsult and Shaun Latter of acsis.

COVER: Are trusts still popular at the moment?

TB: Ten years ago, an occasional dinner-time topic was: “How many trusts have you set up?” Popularity in this sense is no longer evident. The pendulum has swung the other way. Clients set up fewer trusts and are more discriminating in their use. Popularity is not the issue. Relevance, efficiency and appropriate provisions are the key factors. The trust as a financial planning tool is as important as ever; perhaps more so in view of certain legislative and social trends; for example, the growing number of well-to-do families in which children from a previous marriage and children from a current marriage have to be provided for in an equitable manner that respects the wishes of the benefactor.

BB: Trusts can still provide a solution for many situations, but are not necessarily the solution to all problems. Before a trust is created, the way it works must be understood so that the consequences are not regretted later. Trusts are very popular in the correct market. Clients in the affluent market, for whom estate and trust planning are essential, are very much in favour of establishing inter vivos trusts. Not all clients therefore need a trust (or should consider playing in that field) and the asset type, asset value and reasoning behind wanting to establish a trust must be clearly identified and understood.

SL: Trusts soared in popularity a few years ago, because it seemed people felt they needed a trust to ‘belong’. Many of these have subsequently closed as SARS has tightened the legislation regarding the taxation of trusts (and more importantly, some small loophole opportunities). Therefore, the popularity around trusts seems to have levelled off to more purposeful levels. According the Masters Office (where Trust Deeds are registered), approximately 18 000 new trusts have been registered over the past year. Despite the market crash of 2008, wealth in the upper echelon of society has steadily increased and has, to a large degree, dwarfed the increased abatement of R3,5 million set by the Finance Minister a few years ago. Therefore, the popularity which remains is owing to specific benefits that a trust is able to unlock for certain clients.

WF: Trusts have gained a firm foothold all over the world and is a very popular instrument in estate and financial planning. One of the unique characteristics of a trust that adds to the popularity thereof, especially in an estate planning context, is the seperation of ownership from the benefits of ownership. This particular characteristic of a trust makes it an ideal vehicle to achieve certain goals in one’s estate planning.

COVER: Who is using trusts and what is the main motivation?

SF: Generally, trusts are used by high-net-worth individuals in their overall estate and financial plan. The main motivation or objectives of estate planning are: the protection of assets, availability of liquidity and minimizing taxes. However most fiduciary specialists are in agreement that to set up a trust for a person older than 60 years of age may not be viable because of the wealth transfer taxes.

SL: Generally, the trust structure (especially inter-vivos trusts) is most beneficial for high-net-worth individuals and more specifically for those who have significant business interests. This is primarily owing to the potential estate duty savings (or limitation) brought about by pegging the value of growth assets (such as a business or home) through the transfer of such assets into a trust. Secondly, they provide ‘protection’ from creditors, remembering that any outstanding loan account could be attached.

TB: High net worth individuals are the chief users of trust structures. Motives vary. Divorce can be one trigger. A benefactor who can statistically expect to predecease the current spouse by many years may wish to provide properly for the spouse while ensuring adequate provision for children from an earlier marriage. On other occasions, the focus is grandchildren and the need to provide for their private education – an increasingly costly item.

At other times, the motivation is long-term generational planning when the founder of a family fortune wishes to ensure proper wealth stewardship well into the future.

In scenarios such as this, the ability to ‘ring-fence’ assets is crucial.

Recent experience of financial markets suggests we have entered a more volatile era. A successful entrepreneur or senior executive may therefore feel that future financial security cannot be taken for granted. If one’s personal fortunes go into steep decline, having trust structures in place can be highly beneficial as they can protect assets from attack by creditors. This can also be a motivator.

BB: (a) Inter vivos (family) trusts: It is recommended that proper financial and estate planning first be done by an expert who can recommend which assets should be held in trust. Injudicious decisions might be regretted later. Assets such as fixed property and shares, which appreciate the fastest over a period of time, are highly recommended. A trust can also be used to preserve certain assets, such as a holiday home, for descendants. Appreciating assets and not depreciating assets should be placed in trust, yet property speculation should never be done in trust from a cost and tax perspective.

(b) Testamentary trusts: The most common reason is to provide for minors under the age of 18 or for the lifelong maintenance of dependants or beneficiaries who are to inherit only after the age of, say, 21, and for special needs [special testamentary trusts for persons incapable (mentally or physically) of handling their own affairs]. If agricultural land is bequeathed to more than one person but cannot be transferred owing to certain constraints, it could be held in the name of the testamentary trust.As in the case of a family trust, a testamentary trust can also be used to save on estate duty.

Once again proper planning by an expert is crucial. In terms of this, recommendations can then be made about whether certain assets should not be transferred to a family trust during the lifetime of the founder.

COVER: Are clients getting appropriate advice? I see you can get an online trust for between R800 and R1200. Can this ever be sufficient?

WF: Trusts are often formed and used for the wrong reasons without taking a holistic view of the estate owner’s entire estate and financial planning. The nature of each trust and it’s purpose, will determine whether the trust beneficiaries have vested rights to the trust capital and/or income or merely contingent rights which are subject to the trustees exercising their discretion in favour of the trust beneficiaries.

A trust is an important legal document that deals with the rights of beneficiaries and the obligations of trustees. A wrong understanding or application of the relevant legislation can have dire consequences for both advisor and client alike. Trust deeds should in my view only be drafted by persons with the required expertise in estate, trust and tax law. It should always be drafted with the specific needs and unique circumstances of each client in mind. The online version of a trust deed will be sufficient for some people but will not suffice as part of a properly constructed estate plan. Mistakes in the trust deed can have serious consequences.

SF: It is important that clients get professional advice from a reputable person or organization, that is, trust companies, fiduciary specialists and registered financial planners. One-size-fits-all trusts or the cheap online trusts are definitely not sufficient. Trust and tax law in South Africa is ever-changing and it is therefore imperative that the estate planner places his/her trust and confidence in a reputable organisation or experienced person who can look after his/her needs which may also change, namely, death in the family, divorce of parent, birth of a child or his/her acquiring a business.

SL: Although I cannot claim to be an expert on the online versions, the gist of it seems to be akin to the online or ’off-the-shelf’ cc’s. The buying of an online cc will not guarantee business success; neither will having a trust ensure effective estate planning. Although the structuring of the trust is critical, it’s the ongoing management that often determines the success or failure of it. Remember that having the trust deed does not automatically make the trust valid. South African Trust Law is very specific – and at times, pedantic – where everything from electing the correct trustees (to avoid conflict of interests) to opening of bank accounts and the proper auditing of the trust are all factors that will determine the validity of a trust. One simple mistake and it could come tumbling down like a house of cards.

TB: Even well-educated and seemingly well-informed consumers draw on surprisingly varied sources of financial advice – from golf buddies to highly professional financial consultants. It is therefore difficult to say whether appropriate advice is given.

COVER: What role would you like to see financial planners play in the process?

SL: There are three areas where I believe financial planners can play a valuable role in the process. Firstly, to ascertain whether the client would benefit from having a trust as part of his/her estate plan: are there any special needs of dependants? Are there estate duty implications that could be averted or limited? Is creditor protection important? Secondly, to highlight the implications of setting up a trust (both good and bad) and explore the alternatives available (such as life cover to settle the estate duty or even potentially pay the estate duty). Costing becomes an all-important calculation at this stage and everything from CGT, transfer duties, market securities tax through to the ongoing auditing and management of the trust should be considered and weighed up against the benefits and or alternatives. These are the decisions that should be guided and facilitated by the planner, but ultimately made by the client.

Finally, the role of the planner is to refer the client to a trust attorney to set the trust up and manage it from there. Ideally, this should be a firm that the planner has a close working relationship with to ensure continuity of the process and alignment on planning methodology.

Should a planner be a trustee? Taking on the role and responsibility of a trustee is a one that should be carefully considered and only taken on if the planner is a specialist estate planner with in-depth knowledge of South African Trust Law and is prepared to fully commit to the ongoing management of the trust.

TB: Even very good generalist advisers today find it difficult to give ‘best advice’ in the trust arena. It is has become a highly specialised subject. To address the needs of your client properly, you not only have to be on top of today’s demands and current case law and precedents, but the thrust of regulatory and legislative trends.

Cheap, quick and easy online trust establishment is possible. This may suggest that setting up a trust is not too onerous and you do not need any great expertise. Nothing could be further from the truth. To protect assets and fulfil a client’s expectations and objectives can be extremely challenging.

Therefore, the most professional course of action is for the non-specialist to refer the client to a reputable trust company with a proven track record. Even, then, a client should check with referees. No trust professional would object if asked to provide the names and contact numbers of some recent clients.

BB: Apart from being an expert on trusts, an adviser/planner must also bring at least the following to a client’s attention: (a) the cost involved creating a inter vivos (family) trust; (b) how a family trust acquires assets; (b) costs and taxes involved when selling or donating assets, for example, fixed property and shares, to a family trust; and (d) it does not mean your estate is immediately reduced by the amount/value of assets you have transferred to the family trust, except those donated. (e) consequences of trusts, for example, losing control over personal assets, and the duties in terms of act and case law of trustee.

In terms of assisting the middle class, the amendment to Section 4A of the Estate Duty Act (primary rebate of R3,5m) seeks to make the automatic deduction portable between spouses. Therefore, the estate of the surviving spouse will benefit from a double deduction at the time of the surviving spouse’s death (that is, two times the current R3,5 million), less the amount used by the estate of the predeceased spouse (which can never exceed the R3,5 million amount). The proposed amendment will apply in respect of the estate of a person (first spouse) who dies on or after 1 January 2010. Therefore spouses with a short(er) life expectation and assets in total not more than approx R7m with not much growth potential must ‘rethink’ before considering transferring personal assets to a trust (unless for other reasons, for example, saving executors commission in which case it will be better to fixed the fees in their will(s)).

SF: Financial planners play a very important role in the process. They gather the information about the client (estate planner) and his/her family and obtain all the financial information (balance sheet). The prudent financial planner should enquire from his/her client his/her objectives whilst still alive and after death. It is the financial planner’s duty to evaluate the feasibility and sustainability of his/her client’s (estate planner) objectives.

COVER: Are there any specific issues affecting trusts and their application currently? How do we overcome these?

SF: Trusts are subject to the provisions of the Trust Property Control Act of 1988. A trust’s operation is affected by changes in trust law and tax legislation. It is estimated that between 70%-80% of trusts that were drafted pre CGT (2001) have not been subjected to legal audit and it may well be necessary for the trust deeds of these trusts to be amended and updated – an old and outdated trust is a dangerous situation for both the trustees and beneficiaries from a taxation point. Court cases have brought to the fore the importance of an independent trustee and who qualifies as an independent trustee. The lack of independence may open and leave a trust vulnerable to attack if challenged. It is now a requirement that the Master of the High Court will not register a trust unless there is a truly independent trustee.

SL: There are two glaring areas of concern: There are still far too many people setting up trusts for the wrong reasons and many of the trusts may well be deemed ‘invalid’. Many people take out trusts purely to save tax and although tax is an important planning issue, it cannot be the only one. This has led to many people setting up trusts that look and feel like a trust, but are merely an ‘alter ego’ of the individual as the control and benefit of the assets seem to remain with the founder – no guesses how SARS or any court will deal with this. This is one of the issues that could threaten the validity of the trust. Some basic guidelines on a valid trust are:

The parties to a trust include:

  • The founder – the person who creates the trust by bequeathing or donating property or assets to it.
  • The trustees – the people who make decisions regarding the management of the assets or investments in the trust.
  • The beneficiaries – the people who receive the income earned by the property or assets in the trust and who may be entitled to own the property or assets at a later stage.
  • The Master of the Court – the administrator of estates who ensures that the trust adheres to the relevant legislation and oversees the governance of trusts.

There must also be a trust deed upon which the trust is established and contains the rules and guidelines from which the trustees are to gain direction for all decision making. Lastly, and often overlooked, is that a trust must have its own bank account in the name of the trust. This is to pay for all expenses and receive income (such as dividends, etc.).

TB: The big issue is the need to optimise the advantages of trust provision by ensuring the trust is safe from outside attack. Trusts where the only trustees are family members attract increasing scrutiny. In Land and Agricultural Bank of SA v Parker, the Supreme Court of Appeal highlighted areas of possible abuse when there is lack of formality in creating and operating a trust.

The court found that a trust must ensure separation of ownership or control from the enjoyment of trust assets. If a donor transfers assets to a trust but still deals with the assets ‘as before’ there can be no separation of ownership. The trust then offers little protection from challenge – perhaps from creditors or the tax authorities.

Masters of the High Court have been told to ensure trusts are not controlled solely by family members who are beneficiaries. An independent outsider – often a specialist professional – should be made a trustee of trusts in which all current trustees are beneficiaries or where all beneficiaries are related.

COVER: Are there any other issues you would like to raise with regard to trusts?

BB: Individuals will be allowed a tax-free transfer of their domestic residence out of a trust for a period of approximately two years. Such relief will be on similar terms of the previous window period offered in 2002. Like the old regime, the distribution of a primary residence by a trust will be exempt from transfer duty – but still subject to transfer costs. Also, under the renewed relief, the distribution will operate as a roll-over so that all gains or losses will be deferred until the residence becomes subject to a subsequent disposal by the natural person. CGT rollover means the trust is deemed to have disposed of the property at its base cost (that is, no CGT for trust) and the beneficiary acquires the property at its base cost. Therefore, the beneficiary will pay tax on any capital gain when he/she eventually disposes of it. The new roll-over rule replaces the previously granted market value step-up. The beneficiary interest in the trust had to be held by the person living in the residence or his/her spouse, from 11 February 2009 until the date the residence was distributed out of the trust. The residence must be used exclusively for domestic purposes during this period or it must be the sole asset of the trust. This relief will apply to all distributions starting from 11 February 2009 and ending on or before 31 December 2011.

TB: Clients who look to trusts solely for tax advantages should be made aware that though certain tax benefits often accrue, the vigilance of the tax authorities can be expected to increase year by year.

Therefore, the challenge is to maximise all the advantages offered by trust structuring rather than simply focus on tax efficiency. The added value provided by the trust specialist resides in the ability to optimise the full spectrum of generational planning benefits.

WF: Do not think, as so many advisors would like you to believe, that a trust can solve all problems, it can’t. It is only once a client has disclosed and discussed all the relevant circumstances relating to his family financial affairs that an expert opinion can be given whether a trust is the appropriate estate planning vehicle.

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