Testamentary trusts, also known as mortis causa or will trusts, are the most commonly used trusts in South Africa and make for very effective estate planning tools. The process of setting up a testamentary trust appears relatively easy in that it is created via a stipulation in the testator’s will and comes into existence upon his death. But what legal principles apply to testamentary trusts, how do they practically come into existence, and how are they terminated?
The purposes of testamentary trusts
The primary purpose of a testamentary trust is for the testator to protect assets that they intend to bequeath to their minor beneficiaries. However, testamentary trusts make excellent estate planning tools for a number of other reasons which deserve mentioning. Where a testator has special needs children, a testamentary trust set up as a special trust Type A is a tax-efficient way of ensuring that assets intended for mentally or physically disabled children will be protected. Further, where a testator is concerned that their beneficiaries will waste or squander their inheritance, they may choose to house the assets in a trust to be managed by trustees nominated by themself. Where the testator has an asset, such as a holiday home or family farm which cannot be divided amongst multiple beneficiaries, they may choose to bequeath such an asset to a testamentary trust and appoint their heirs as beneficiaries to the trust.
Setting up a testamentary trust
Unlike an inter vivos or living trust which is created by the trust founder through a trust deed, a testamentary trust is set up via the testator’s will – meaning that the will becomes the trust instrument, and the testator is known as the trust founder or settlor. Generally speaking, the testator will include a special paragraph in their will setting out the formalities of the trust, although it is possible for the testator to attach a trust deed to their will. The wording of the will must clearly indicate the intention of the testator to create a trust, who the beneficiaries are, and which assets should be bequeathed to the trust. In addition, the will must set out the terms and conditions that apply to the trust, and nominate trustees to manage the assets of the trust.
What is particularly important to consider when setting up a testamentary trust is that, if the will is found to be invalid for any reason – keeping in mind that the Master of the High Court has the power to declare a will invalid – the testamentary trust will not come into existence, making it essential for those drafting a will to seek professional advice and expertise.
Trustees have a fiduciary duty to manage the trust assets in the interests of the beneficiaries and in line with the terms and conditions set out in the will. It is essential to nominate trustees who have the knowledge and skill to manage the assets of the trust, and who you believe will do so in the best interests of your minor beneficiaries. After the passing of the testator, it is the duty of the nominated trustees to apply to the Master of the High Court for what is known as Letters of Authority. The child’s appointed guardian does not need to be a trustee, and it is advisable that the guardian and trustees are separate – to keep checks and balances. Generally speaking, it is advisable to appoint a maximum of three trustees, with one of them being a professional, independent person with experience in managing trusts.
Trust legislation and legal principles
All trusts, as legal entities, are governed by the Trust Property Control Act and the trustees are required to ensure that they comply with this legislation. It is important to note that the legal principles that apply to a living trust, which takes the form of a contract between the trust founder, trustees and possibly the beneficiaries, is based on the law of contract, whereas the legal principles relating to the law of testation apply to testamentary trust. That said, all trusts are considered legal entities created to hold assets for the benefit of others, but are not separate juristic persons and are therefore incapable of suing or being sued.
Inheritance of minors
In terms of South African law, children under the age of 18 do not have the legal capacity to enter into contracts without the assistance of a legal guardian and cannot directly inherit assets. In the absence of a testamentary trust and where a testator bequeaths assets directly to their minor children, such assets will not be inherited by the minor children until they reach age 18. Any cash left to a minor child, such as the proceeds of a life policy, will be held by the Guardian’s Fund which is administered by the Master of the High Court until the child reaches the age of majority.
Tax rates of testamentary trusts
The rate of income tax applicable to special trusts is the same as for natural persons on a sliding scale relevant to the income brackets, but such a trust must be set up in terms of the Income Tax Act in order to qualify for this favourable tax rate. If the trust is registered with Sars as a Type A trust in favour of a mentally or physically disabled beneficiary, such a trust will enjoy tax rates applicable to natural persons ranging from 18% to 45%. In addition, the annual CGT exclusion of R40 000 is available to this trust, as well as the primary residence exclusion of R2 million of the capital gain on disposal for CGT purposes.
Contesting or changing a testamentary trust
Freedom of testation is a founding principle of the South African law of succession and, as such, it is extremely difficult for anyone to challenge the terms of a testamentary trust. Just because a beneficiary is aggrieved at being excluded from a trust, does not mean they have the legal right to have the trust instrument changed to include them. Generally speaking, it is also not possible for the trustees of a testamentary trust to amend the trust instrument as one of the parties to the contract, being the testator, is no longer alive to agree to the changes. Notably, trust beneficiaries do have the legal right to relinquish their rights.
Termination of a testamentary trust
Generally speaking, the appointed trustees will continue to manage the trust assets in accordance with the will until the trust terminates, which is usually after a pre-determined period or event. For instance, the will might stipulate that the trust should terminate when the youngest beneficiary reaches age 23.