Far-reaching tax law changes to curb the avoidance of estate duty may have created the impression that trusts are no longer relevant.
Section 7C of the Income Tax Act that took effect on March 1, 2017 was specifically aimed at an estate-planning practice of moving assets to a trust while extending an interest-free loan to the trust (effectively allowing assets to grow in value outside the estate of the original owner and reducing tax revenue for the fiscus), but the practice is not that common where testamentary trusts are concerned, Louis van Vuren, CEO of the Fiduciary Institute of Southern Africa (Fisa), says.
While Section 7C applies to all trusts (including testamentary trusts) a testamentary trust can still be a useful estate planning tool without punitive tax implications.
There are two instances where a testamentary trust can be particularly advantageous.
As there is always a possibility that a person under the age of majority (18) may become entitled to a benefit in terms of a will, a testamentary trust should be a standard provision in any will, says Van Vuren.
The Administration of Estates Act stipulates that any benefit bequeathed to someone under the age of 18 must – in the absence of provision for a trust – go to the Guardian’s Fund. The Guardian’s Fund administers funds paid to the Master of the High Court on behalf of minors, among others.
“Even where the deceased did not have any descendants … if all the bequests in the will should fail, the benefits could end up with somebody who is under the age of 18, and then you want that to go into a testamentary trust rather than into the Guardian’s Fund,” Van Vuren says.
Should the will provide for the formation of a testamentary trust for minors, and all beneficiaries are 18 or older, the provision will simply be ignored.
Although the interest paid for the benefit of minors in the Guardian’s Fund is relatively competitive, there are various other factors to consider.
The Guardian’s Fund pays interest annually to the guardian of the beneficiary – no tax planning is possible. The asset allocation of the fund also makes it difficult to ensure adequate capital growth to neutralise the impact of inflation, Van Vuren says.
An overall maximum of R250 000 in capital can be withdrawn from the fund until the minor turns 18, regardless of how much money was paid into the fund.
For example, if the minor inherited R2 million that was transferred to the Guardian’s Fund, the guardian will be entitled to the applicable interest on R2 million, but if this is not sufficient to provide for the minor, only R250 000 in capital can be withdrawn prior to the minor’s 18th birthday. The rest (R1.75 million in this case) will only be paid to the beneficiary when they turn 18.
Moreover, only money can be transferred to the Guardian’s Fund. Fixed property will have to be registered in the minor’s name and movable property will be handed to the legal guardian to be managed for the minor’s benefit. If it becomes necessary to sell fixed property on behalf of a minor, this can only be done in terms of a High Court order, Van Vuren adds.
In contrast, if the fixed property is in a testamentary trust for the benefit of the minor, the trustees can sell the property if it is in the best interest of the beneficiary, Van Vuren says.
With the Guardian’s Fund, there is no scope to delay the distribution of the remaining funds to a date after the minor’s 18th birthday, as could be done in a discretionary testamentary trust, he adds.
Maintenance of a surviving spouse
Testamentary trusts can also be useful to ensure adequate maintenance is paid to the surviving spouse while protecting the assets for future generations. This is important where the surviving spouse is not related to the children or grandchildren of the deceased.
Van Vuren says in such cases, a testamentary trust can be used to safeguard the property of the deceased, while ensuring that assets are available to provide maintenance for the surviving spouse.
If certain requirements are met, a bequest to any trustees in a testamentary ownership trust who have a vested right to the net income in favour of the surviving spouse can qualify for a deduction of estate duty.
“The trust capital can then, after the death or re-marriage of the surviving spouse, be distributed to the children of the original testator.”
Van Vuren says this is a good way of ensuring that the children’s inheritance is protected against the impulses of the surviving spouse or their new partner, while also providing for the maintenance of the spouse.
While trusts pay tax at 45%, a ‘special trust’ is taxed as an individual on all income retained in the trust (income not paid to beneficiaries). Although it doesn’t qualify for the tax rebates offered to individuals, the tax dispensation for special trusts is much more favourable.
A testamentary trust for family members can qualify as a special trust as long as one of the beneficiaries is still a minor. A family member can be a grandchild as well, says Van Vuren.
“Any income distributed to a beneficiary will be taxed in the hands of the beneficiary, which means that in the case of a minor beneficiary, it is unlikely to be taxed unless there is a lot of income [because the minor is unlikely to have any other income].”
A testamentary trust for the benefit of a physically or mentally disabled person can also qualify as a special trust, he adds.
Brought to you by the Fiduciary Institute of Southern Africa (Fisa).