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Using a trust effectively

One of the biggest benefits of using a trust is to transfer assets without incurring transfer duties or death taxes.

A trust can be tricky to properly describe. This may be partly due to the fact that a trust exists primarily on paper.

A trust can be described as a legal relationship between the founder of the trust, who places assets in the trust for the benefit of a third person, called the beneficiary. The trust is placed under the control of a third party, known as the trustee.

A trust is a legal entity itself, so it is not a contract, and is in most cases the owner of any assets within the trust. For example, if a founder wants to set up a trust for his holiday house that will be rented out to holiday makers, the founder sells the house to the trust. The beneficiaries of the trust receive the rental income from the trust, but the trust itself owns the holiday house.

One of the main reasons that trusts are used, is to protect the trust assets from the beneficiaries. Trusts are an effective instrument to transfer assets through generations and as such any investment made by the trust is generally going to have a long-term time horizon. Farmers often used to put their farms into a family trust and in that way, when the farmer passes away the farm can continue operating. This is one of the biggest benefits of using a trust: to transfer assets without incurring transfer duties or death taxes.

Tax solutions

One of the drawbacks of a trust is that any income retained in a trust and not distributed to a beneficiary is heavily taxed. Using tax-effective mechanisms within a trust is a very good strategy to reduce the tax burden.

An ideal solution is for a trust to invest using an endowment. There are however certain restrictions on endowments, such as a limit on withdrawals in the first five years. However, the tax benefits can outweigh the downside, especially when considering that the horizon will generally be longer than five years.

A benefit is that endowments are taxed at a flat rate of 30% for trusts, which is much lower than the 45% that income retained in a trust is taxed at. An endowment further pegs the income tax at 30% and the capital gains tax (CGT) effective rate can be as low as 12% (the normal effective rate for CGT in trusts is 36%). Endowments have been used in South Africa for many years as an efficient and tax-effective way to invest. Using an endowment within a trust takes this concept one step further.

Another fact to consider is that a local trust, that is a trust formed and domiciled in South Africa, cannot invest offshore directly. Given that the fees charged to administer trusts restrict them to the wealthier segment of society – a group who tend to be more desirous of investing offshore – this can be a potential drawback. Within the endowment structure, the investment portfolio can however have an offshore allocation and thereby have offshore exposure.

When placing an investment in the name of the trust, you need to keep in mind that you will need to meet Fica requirements. While some people consider Fica nothing more than an irritating hurdle, the reality is that Fica is a very important tool to fight money laundering. All financial service providers (FSPs) are required to ensure that they know where the funds used to make any investments or to purchase a financial product came from. If there is any suspicion that money laundering is involved, the FSP has a duty to inform the Financial Intelligence Centre (FIC), which will then investigate further. The regulations around how a FSP identifies clients and determines the source of wealth has become far more stringent this year, so understand that you will need to comply with the Fica requirements. Trusts don’t let you off the hook with this.


The normal rules of investing apply to trusts. Any investment should be diversified in a mix of asset classes – such as equities, property, bonds, and cash – according to the aim of the investment.

Given that investing as a trust will generally have a longer time horizon, the investment should be more biased towards growth assets such as equities and property.

The big difference between investing via a trust as opposed to in your individual capacity is the tax treatment. Sars taxes any income retained in the trust at the maximum individual rate, currently 45%. In addition, the inclusion rate for CGT for any capital disposals, such as selling a beach house or a unit trust portfolio, is 80%. To put that in perspective, the inclusion rate for individuals is 40%. The reason it is so high is an effort on the part of Sars to force trusts to use the conduit mechanism of a trust and let the income and capital gains flow through to the beneficiaries.

Money invested through a trust is often the accumulation of intergenerational wealth, money that is created and passed down from generation to generation. This type of money needs to be properly nurtured, and this often requires the input of offshore exposure. A trust can get offshore exposure by investing in local funds that have an offshore component. By sitting these investments within an endowment, the trust can reduce its tax burden substantially.

Being smart with your money is crucial, and tax efficiency is vital in building wealth. Make sure you are discussing how best to structure your wealth through the effective use of trusts with the guidance of a qualified financial advisor. Read more about estate planning here.

Do you have any questions you would like answered by registered financial planners?



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