Testamentary trusts, also referred to as will trusts or trusts mortis causa, are the most commonly used trusts in South Africa largely because they have a number of significant estate planning benefits. Unlike living trusts which are formed during the lifetime of the trust founder, a testamentary trust only comes into existence on the death of the trust founder with one of its primary purposes being the protection and preservation of assets intended for minor children. In this article, we have a closer look at how parents of minor children can use a testamentary trust in their estate plan.
The legal position of minor children
In our country, children under the age of 18 are considered minors and do not have legal capacity to enter into agreements or contracts without the assistance of a legal guardian – and this impacts their ability to inherit directly. By providing for the formation of a testamentary trust in the event of your death, you can proactively ensure that any assets intended for your minor children can be housed in the trust following your death where they will be protected and preserved until your children are old enough to manage their own financial affairs.
Reasons for using a testamentary trust
If you intend bequeathing assets to a child who is still a minor, your intentions may be thwarted as a result of his/her legal incapacity to inherit directly. In the event of your death, funds bequeathed to your minor child will be housed and administered by the state-run Guardian’s Fund which falls under the administration of the Master’s Office until your child reaches the age of majority. Any immoveable property bequeathed to a minor child will be registered in your child’s name but managed by the child’s legal guardian until he/she reaches age 18. Accessing funds held in the Guardian’s Fund can be a hugely frustrating process, and many guardians struggle with red tape and bureaucratic processes that scupper the timeous payout of funds intended for the child’s welfare. Further, investment growth in the Guardian’s Fund is generally below standard which adversely affects the capital growth of the assets. There are also annual limits on the amount of money that the child’s guardian can access from the fund which may leave your child short of funds.
Requirements for a valid trust
As with all trusts, there are a number of requirements that must be met in order for the trust to be valid. This type of trust is created by including a clause in your will which in essence serves as the trust deed. Most importantly, your will must contain clear evidence that you intend to create a trust and must clearly identify the property or assets that should be moved into the trust on your passing. The trust beneficiaries must be clearly identified as should your nominated trustees who, upon appointment, will have a fiduciary duty to manage the trust assets in the best interest of your minor children. The area of trusts is a specialised area of estate planning and it is advisable to seek the assistance of an expert when setting up a trust in your will. Remember, if for whatever reason your will is found to be invalid, the testamentary trust will not come into effect and this can have unintended, adverse financial consequences for children.
The trust instrument
When it comes to setting up a testamentary trust, your will is effectively the trust instrument as it provides the legal mechanisms for the establishment of the trust in the event of your death. Your will should therefore set out the terms and conditions that apply to your trust, make trustee nominations, and provide guidance to the trustees as to how you would like the assets to be managed for the benefit of your minor children. For example, your trust deed can provide the trustees with a mandate to invest funds and surplus income for the benefit of the trust, and at their discretion provide for the maintenance and education costs of your children until they reach a pre-determined age. In general, testamentary trusts provide the trustees with broad discretionary powers to make decisions when it comes to managing the trust’s assets.
Parties to the trust
The parties to a testamentary trust include the testator (being the trust founder), the trustees, and the trust beneficiaries (the minor children). As the trustees will be tasked with managing your children’s inheritance until they are old enough to do so themselves, it is essential that you have full confidence in your trustees. Ideally, consider appointing three trustees including an independent trustee with fiduciary experience to ensure that the trust is properly controlled and managed and that tax efficiency is achieved. While it is possible to appoint your child’s legal guardian as a trustee, you are not obliged to do so.
The formation of the trust
Upon your death, your testamentary trust will come into formation and the assets identified in your will must be transferred to the trust. Your nominated trustees must apply to the Master of the High Court for letters of authority which will allow them to set up and manage the trust as per your instructions. The duration of the testamentary trust will depend on the terms and conditions that you have included in your Will. For instance, you may choose for your trust to remain in existence until each beneficiary reaches age 25, following which the trust will terminate. In general, a testamentary trust will terminate once the nominated beneficiary reaches a certain age, after a pre-determined period of time, or on the death of the income beneficiary. A testamentary trust can own immoveable property, receive donations and inherit money from your estate when you die, and is a secure way of ensuring your assets are correctly managed by people you know and trust.
Special testamentary trusts
If one or more of your children suffers from a mental and/or physical disability, it is possible that your testamentary trust will qualify as what is known as a ‘special trust’, thereby allowing it to benefit from a more favourable tax dispensation. A special trust set up for the benefit of a disabled person can be formed in terms of the Income Tax Act provided that the requirements in terms of the Act are duly met. To qualify as a special trust, the disabled beneficiary (or beneficiaries) must have a disability that limits his or her ability to function or perform daily activities which can include physical, sensory, communicative, intellectual, or mental impairment. Further, the beneficiary must have been diagnosed by a registered medical practitioner, must have suffered from the impairment for a period of at least 12 months, and the impairment must be deemed to be permanent in nature. Importantly, this type of trust must be set up solely for the benefit of the disabled person, and, in the case of more than one disabled beneficiary, such beneficiaries should be related. Assuming that your trust qualifies as a special trust, it will be taxed at rates applicable to natural persons will be applicable. 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.
Questions to consider before setting up a testamentary trust:
- Do you have minor children?
- Do you intend to leave funds to your minor child in the event of your death? (This would include proceeds of a life policy where your minor child is a nominated beneficiary but excluding death benefits from a retirement fund)
- Do you intend to bequeath immoveable property, or a part thereof, to a minor child?
- In the event of your death, who would be your child’s legal guardian?
- Do you have a child with a mental or physical disability that is permanent in nature?
- In the event of your passing, how much would your child’s guardian need to provide for your child’s living and education expenses? Until what age would you like to provide financially for your child?
- Who would you trust implicitly to manage the trust’s assets?
- How much discretion are you comfortable giving to your trustees?
- Knowing your child, at what age do you feel he/she would be responsible enough to manage their own financial affairs?
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