Protecting and transferring generational wealth

An important part of one’s strategy to create wealth is to ensure that it is protected and transferred in a methodical, cost-effective manner to the next generation. The process of transferring wealth from one generation to the next can be gradual or expeditious, during one’s lifetime or post-mortem, or a combination of both, depending on the objectives and intentions of the estate planner. Further, the manner in which you choose to transfer an asset to the next generation depends on a number of factors such as the nature, type and location of the asset, the intended beneficiaries, the number of beneficiaries, your ultimate intentions for the asset, and the value of the asset, amongst other things. In this article, we explore the various mechanisms available to estate planners who wish to transfer their assets.

(i) During your lifetime

There are two primary mechanisms available to an estate planner who wishes to transfer assets to the next generation during his lifetime, being (a) setting up an inter vivos trust and (b) making donations.

(a) Inter Vivos trusts

Living trusts can be highly effective for housing and protecting growth assets intended for future generations, although it is important to be clear on your reasons for setting up an inter vivos trust. At the outset, the trust founder must appreciate that, upon transferring assets to the trust, he essentially loses control of those assets which then fall under the control of the trustees. As such, the trust founder must be absolutely comfortable with losing control of those assets during his lifetime in favour of his nominated beneficiaries. While living trusts can be used to reduce estate duty and taxes, this should not be the primary intention of the trust founder, but rather as supplementary benefits to his primary intention to transfer assets during his lifetime. The real benefit of a living trust is that because trusts don’t die, assets housed in a trust can move from generation to generation without being subject to estate administration and the associated costs thereof. Further, where growth assets are transferred into a living trust – which is generally done through sale or donation – the value of the asset is pegged in the trust founder’s personal estate while all growth in the estate takes place in the trust. This process, known as ‘estate pegging’, can be used effectively to reduce estate duty and other tax liabilities in a person’s estate so as to enhance estate liquidity and maximise the assets available for distribution amongst heirs. For example, let’s assume Mrs Samsodien owns a holiday home valued at R2 million which she would like to protect for use by her children, grandchildren and their offspring. By leaving the holiday home in her personal estate, in the event of her death, the property will be administered as part of her deceased estate. If there are any liquidity shortfalls in her estate, the executor may need to sell the holiday home in order to pay the costs in the estate. If her estate is adequately liquid, the property will transfer to her intended beneficiaries which in the case we assume are her three children. Subsequently, Sibling A and B decide to emigrate and wish to sell their respective shares of the holiday home to Sibling C who unfortunately does not have cash available to purchase the shares – and subsequently, the three children decide to sell the property.

On the other hand, let’s assume that Mrs Samsodien sets up a trust into which she transfers the holiday home by selling it to the trust for an amount of R2 million with a loan account reflected in her personal estate. By using her annual donations tax exemption of R100 000, Mrs Samsodien reduces the value of the loan account incrementally which, in turn, reduces her estate duty liability over time. Further, the value of the property is pegged in her estate at R2 million while any growth in the value of the property takes place in the trust. As her three children are the nominated beneficiaries of the trust, she also avoids the problem of bequeathing fixed property to multiple heirs which can cause complications when it comes to the actual distribution of the asset. In founding the trust, Mrs Samsodien drafts a clearly worded trust deed which sets out her intentions for the holiday home (i.e. that it be retained for future generations) and provides her nominated trustees, who include an independent trustee not related to the family, with (amongst other things) a clear mandate for managing the trust asset. As is evident from the above, a living trust can be strategically used to transfer assets during one’s lifetime and is most appropriate where the estate planner intends for the property to be kept for a longer period of time and the benefit of successive generations.

(b) Donations

Another mechanism for transferring assets during one’s lifetime is by making donations, although it is important to understand the donations tax implications of doing so. Donations Tax is calculated at a flat rate of 20% on the value of the donation up to R30 million, and at a rate of 25% on donations over and above R30 million. However, SARS makes provision for a Donations Tax threshold of R100 000 below which no donations tax is payable meaning that a taxpayer can use this annual exemption to transfer assets during his lifetime on a tax-free basis provided the cumulative total does not exceed R100 000 in a tax year. As highlighted in point (a) above, trust founders can use this annual exemption to reduce the value of the loan account in their personal estate

(ii) Post-mortem

When it comes to transferring assets to future generations after your passing, there are several mechanisms which can be used, although two bears specific mention, namely (a) testamentary trusts and (b) living annuities. Both are useful estate planning tools in that the assets held in these respective structures do not fall into one’s personal estate and therefore bypass the estate administration process.

(a) Testamentary trust

A testamentary trust, which comes into existence on your death, is set up in your Will which then becomes the trust instrument or founding document. By setting up a testamentary trust, you can ensure that certain pre-determined assets are transferred directly into the trust in the event of your death where they will be administered by your nominated trustees. This type of trust can be used effectively to house and protect assets intended for minor children who, in terms of our law, lack contractual capacity and therefore cannot inherit directly. By transferring these assets into a trust, you can ensure that the assets will be safely administered until your minor children reach a pre-determined age. Testamentary trusts can also be used to provide for special needs children who as a result of physical or mental incapacity are incapable of managing their own affairs. Where the special needs beneficiary meets the criteria set out in Section 6B (1) of the Income Tax Act it can be registered as a special trust (Type A) and privy to more favourable tax rates. Whereas normal trusts are taxed at the highest rate of 45%, Type A trusts are taxed as natural persons on a sliding scale of 18% to 45%. They also enjoy an annual CGT exclusion of R40 000 as well as the R2 million primary residence exclusion of the capital gain for CGT purposes. On the death of the trust founder, the assets held in trust will not be subject to the estate administration process and will be available immediately for the beneficiaries.

(b) Living Annuity

Nominating beneficiaries to your living annuity is an excellent way of ensuring that your loved ones receive their benefits without having to wait for your estate to be wound up. This is because the funds invested in a living annuity fall outside of your deceased estate and, as such, are not taken into account when determining your estate duty liability. Unlike approved retirement funds, owners of living annuities have freedom to nominate beneficiaries (including trusts) to the annuity thereby ensuring that the nominated beneficiaries have almost immediate access to the funds in the event of your death. Remember, winding up a deceased estate can take up to two years or more, depending on the complexity of the estate and whether any administrative delays are encountered, and if you haven’t made provision for your loved ones to have access to capital, they could find themselves cash-strapped while waiting for your estate to be finalised. In the event of your death, your nominated beneficiaries will have the option to withdraw the full amount of capital invested in your living annuity, although they will be taxed as per the retirement tax tables applicable to you. Your beneficiaries may also consider making a partial withdrawal while transferring the balance into a living annuity in their own name. Additionally, they can choose to leave the living annuity where it is, keeping in mind that they can adjust the underlying investment strategy and drawdown levels in accordance with their needs.

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