Article by Helen van Staden (Independent Wealth Managers)

WHAT IS A TESTAMENTARY TRUST AND HOW IS IT CREATED?

When it comes to estate planning, you should always consider the objective at hand for deciding on the type of trust to use. A Testamentary Trust is the most commonly used form of trust in South Africa and is an effective Estate Planning tool.

A testamentary trust, sometimes referred to as a Will trust, only comes into existence on your death and is created through a clause in your Last Will and Testament, which serves as the Trust Deed.

An estate planning expert should be consulted when drafting a Last Will and Testament that includes a Testamentary Trust; If your will is found to be invalid for any reason, the trust will not come into effect, with potential dire consequences for your beneficiaries. In addition, when creating a Testamentary Trust in your Last Will & Testament, there are certain formalities which must be adhered to, such as the following:

• Your intention to create a Testamentary Trust should be clear
• You should specify exactly which assets should be bequeathed to the trust
• You will need to nominate the trustees and the beneficiaries of the trust
• The responsibilities of the trustees should be set out
• You should advise how the trust assets should be managed for the benefit of the beneficiaries
• You should advise when the trust should be terminated and if the trustees have the discretion to extend this date should they see fit

It is important that your appointed trustees have the financial knowledge to manage and protect the trust assets, in a tax efficient manner, for the benefit of the beneficiaries. In the case of a minor child, it is not necessary to appoint the child’s guardian as a trustee; it is at times better to separate the role of guardian and trustee. More than one trustee should always be appointed, this will avoid the court from having to appoint a trustee in the instance where the appointed trustee may be unable to fill the role at the time of death. It also allows for more than one person to consider the needs of beneficiaries and to act objectively. It is preferable to have an odd number of trustees, such as 3, to avoid any disagreements from prohibiting decisions being made. Being a trustee is a time consuming commitment and should therefore be discussed with the desired trustee before appointing them.

WHY CONSIDER SETTING UP A TESTAMENTARY TRUST IN YOUR ESTATE PLAN?

A Testamentary Trust is used to protect the inheritance of your spouse, children and/or other beneficiaries of your Last Will & Testament.

You may fear that your inheritance to a child or spouse will not be used as intended in the event of your death, resulting in your spouse or child not being provided for. You may also worry that they or other beneficiaries may not have the financial know-how to manage their inheritance or financial affairs in general. Or, perhaps, you want to provide an income for your spouse during her lifetime while protecting the capital for future generations, this is particularly important where your spouse may not be related to your children / other beneficiaries.

To protect your spouse, children and other beneficiaries of your Last Will and Testament, the Will should protect any benefit from any joint estate or marital regime, in essence ring fencing the inheritance from being part of any joint estate. However, there are still ways that an inheritance may be at risk. Once the capital is utilised towards joint assets (like properties or businesses) or to fund a lifestyle, it can become a grey area trying to prove what portion of funds that were contributed formed part of the inheritance as time passes and assets grow. This is where a Trust can keep things clear, as assets will either be purchased in the entity or loans will be recorded and accounted for over time to the beneficiaries.

The same principle applies for debtors; even if the assets are ring fenced in the beneficiary’s hands, should they marry in community of property, the debtors of one spouse are considered to be the debtors of both spouses jointly. Therefore, if your beneficiary marries someone who is in debt, the debtors of the new spouse will be able to claim against your beneficiaries inherited estate. There is no way around this and no stipulation that could be used in a Last Will & Testament to counteract this. In this case a Trust would also be used to protect the assets, as they have not vested in the beneficiary and as such are not their assets, so long as the Trustees have discretion.

WHAT HAPPENS TO MY MINOR BENEFICIARIES’ INHERITANCE IF NO TESTAMENTARY TRUST IS IN PLACE?

If you do not create a Testamentary Trust and it is possible that a minor (under age of 18) will benefit, it is vital to state in the Last Will and Testament that any minor’s portion shall be paid to their guardian and not the Guardians Fund.

In the absence of a Testamentary Trust and the above clause in you Last Will & Testament, any bequests to minor children will be held by the Guardians Fund, which is administered by the Master of the High Court, and the funds will therefore effectively be managed by the state.

WHAT ARE THE ADVANTAGES OF CREATING A TESTAMENTARY TRUST?

The following are additional advantages, to those mentioned above, of creating a Testamentary Trust:

• If the youngest beneficiary of a Testamentary Trust is under the age of 18 years on the last day of the tax year, the trust will not be taxed at 45% like a normal trust. In this instance the Testamentary Trust will be taxed as per the normal sliding scale for individuals and will be classed as a special trust. If the testamentary trust has been established for a mentally or physically disabled child, this will also qualify as a special trust
• A trust has continuity and can therefore survive the life of an individual and extend over multiple generations providing uninterrupted succession planning
• No donations tax or transfer duty is levied on the transfer of assets to a Testamentary Trust. In addition, there is no loan account created by way of any assets inherited by the Trust
• A trust has continuity and can therefore survive the life of an individual and extend over multiple generations providing uninterrupted succession planning
• Once the trust has been established, no further estate duty will be levied on the trust assets as long as they remain in the trust

WHAT ARE SOME OF THE CHALLENGES THAT I MAY ENCOUNTER WHEN CREATING A TESTAMENTARY TRUST?

• A Testamentary Trust is fairly inexpensive to create, however can be costly to maintain, especially, if the trustees require legal advice on how to administer the trust
• There will be fees levied to prepare financial statements as well as for the filing of any SARS tax returns
• When assets are placed in a trust there is a loss of ownership / control over these assets and the trustees are now responsible for how they are used / distributed
• Capital Gains Tax is levied on all assets transferred to a Testamentary Trust and is payable from your estate on death. To the extent that the assets exceed R3.5million, Estate Duty will also be payable. Both taxes are only avoided through assets left directly to a spouse. If left to the guardian of minor children, these taxes will still be levied.

ARE TESTAMENTARY TRUSTS STILL USEFUL?

SARS have implemented tax law changes such as Section 7C of the Income Tax Act, in an attempt to stop individuals from utilising trusts to avoid paying estate duty on death. This may give you the impression that Trusts are no longer useful. Section 7C does apply to all trusts, however, Testamentary Trusts are still an effective estate planning tool without onerous tax consequences.

A Testamentary Trust is an extremely useful tool for estate planning purposes and can be used as a vehicle to assist with succession planning over generations. Based on the above, we can clearly identify the relevance of establishing a Testamentary Trust under certain circumstances. A Testamentary Trust will aid you in avoiding the undesirable consequences that could arise, should you not make provision for a Testamentary Trust in your Last Will & Testament.

Should you require any Estate Planning assistance or have any queries, please do not hesitate to get in touch with us.