The important role of special trusts

The Income Tax Act makes provision for the creation of special trusts and, as their name indicates, these trusts are designed to serve a specific purpose in an estate plan: to protect and ensure safe custody of assets intended for those who, for whatever reason, are unable to manage their financial affairs. In this article, we explore the valuable role that these types of trusts can play in your estate plan, and how to implement them effectively.

At the outset, it is important to understand the difference between a special trust Type A and Type B, both of which are set up in terms of Section 6B (1) of the Income Tax Act. Type A trusts are specifically created for the benefit of a person who suffers from a mental illness as defined in terms of the Mental Health Care Act, or from a serious physical disability. On the other hand, a special trust Type B is created for the benefit of minor relatives of the deceased who are under the age of 21. With this important distinction in mind, we explore three scenarios in which a special trust can be used in one’s estate plan.

(i) Providing for your special needs child

If you have a special needs child that suffers from either a severe mental or physical disability who, as a result, is unable to manage their financial affairs, a special trust Type A can provide a highly effective solution to ensure that your child is provided for into the future. Depending on your requirements, a Type A trust can be set up as a testamentary trust so that it only comes into formation in the event of your death, or as a living trust which is formed during your lifetime. If, for instance, there is a geographical distance between you and your special needs child, or if you spend long periods abroad, setting up a living trust for her benefit may make sense. In doing so, the appointed trustees can administer the trust assets in the best interests of your child and in accordance with the powers granted to them in terms of the trust deed. On the other hand, if you are confident that you can manage your child’s affairs but are concerned about her welfare in the event of your death, then a testamentary trust created in terms of your Will would be appropriate. While this type of trust can take the form of either a discretionary or vested trust, given that your special needs child is not capable of managing her financial affairs, it would be advisable to set up the trust as a discretionary one. Whether you choose to set up a testamentary or living trust, keep in mind that it is important to carefully select your trustees as they will assume full responsibility for the financial welfare of your child, and you need to trust them implicitly to act in your child’s best interest, especially when you are no longer around. Remember, as the trust founder of an inter vivos trust, you can nominate yourself as a trustee – ideally together with two other trustees, one of whom is independent. This will provide in-built checks and balances and ensure that there is independent oversight by a fiduciary expert.

Requirements: There are a number of requirements that must be met in order to qualify as a Type A trust. In the first instance, the beneficiary for whose benefit the trust is set up must suffer from a mental or physical disability that limits her function to perform daily activities, and their condition must have been diagnosed by a registered medical practitioner. Further, the condition from which she suffers must be deemed irreversible. Most importantly, keep in mind that this type of trust must be solely for the benefit of a special needs beneficiary.

(ii) Protecting the inheritance of minor children

If you have children under the age of 18, keep in mind that in terms of our law, they are incapable of inheriting directly. This means that any assets bequeathed directly to them may either be held in the Guardian’s Fund until they reach the age of majority or administered on their behalf by their guardian. To ensure that their intended inheritance is protected and appropriately managed, you can set up a testamentary trust in terms of your Will in which all assets intended for them are bequeathed to the trust. Upon your death, the trust will be formed and the earmarked assets will be transferred into the trust as part of the estate administration process. Once formed, your nominated trustees will take over the management of the assets for the benefit of your minor children and, once again, it is advisable to appoint three trustees, one of whom is an independent expert. This type of trust takes the form of a Type B trust which is specifically designed to house assets for the benefit of minor beneficiaries. Depending on your objectives, you can set the trust up as a discretionary trust where the trustees have full discretion in terms of how the capital and income of the trust is distributed to the trustees, or as a vested trust – however, given that the trust beneficiaries will be minors, it would be advisable to set up the trust as a discretionary one.

Requirements: The relatives for whose benefit the trust is registered must be alive on the date of your death, and the youngest of the beneficiaries must be under the age of 21 on the last day of the year of assessment. Upon formation, the trustees would need to register the trust with SARS.

Tax: Type B trusts enjoy tax rates applicable to natural persons ranging from 18% to 45% apply, but not the other tax benefits applicable to a Type A trust.

(iii) Managing your affairs in the event of mental incapacity

If circumstances where you have received an early diagnosis of a disease that will ultimately affect your mental capacity – such as dementia, Alzheimer’s or motor neuron disease – it is possible to set up an inter vivos trust and to transfer your assets into the trust for management by your nominated trustees, although it is important to ensure that you do so while you still have full mental capacity and before the disease progresses to the point where you are no longer considered mentally competent. In setting up the trust, you are able to transfer your assets into the trust either by donating to the trust or by selling the relevant assets to the trust in the form of a loan account. Because of your mental illness diagnosis, this type of trust would take the form of a discretionary trust meaning that your trustees will have complete say as to how the income and capital will be distributed to you. Once again, carefully selecting your trustees is important as they will be responsible for managing the trust assets for your benefit and making decisions on your behalf. As such, it is essential that your trust deed is carefully worded to ensure that your trustees have a clear understanding of their mandate. While this type of structure is an excellent solution for those suffering from a mental illness who want to put plans in place to ensure that their affairs are well-managed, it is critical to implement the solution before mental deterioration takes place. Once you are considered mentally incapable of managing your affairs or entering into contracts, you will not be able to set up a trust, and the options available for the management of your affairs become limited to the appointment of a curator bonis or administrator.

Requirements: To be registered as a Type A trust, your mental condition must be diagnosed by a registered medical practitioner and must meet the criteria as set out in terms of the Mental Health Care Act. Once again, it is important that your condition must be permanent in nature, and the trust must be set up solely for your benefit, and not for any other reason.

Tax: As a special trust Type A, the annual CGT exclusion of R40 000 is applicable, as well as the primary residence exclusion of R2 million of the capital gain on disposal for CGT purposes. Once again, this type of trust will need to be registered with SARS in order to enjoy these tax benefits.

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