A living trust is set up during the life of the trust founder to achieve a specific set of estate planning goals. By transferring certain assets into the trust, the trust founder must relinquish control of those assets to the trustees whose job it is to administer the trust assets in accordance with the trust deed in the best interest of the trust’s beneficiaries. A living trust can be used effectively to protect assets intended for the founder’s beneficiaries, limit estate duty, plan for the succession of assets, or protect assets from creditors. In this article, we explore how living, or inter vivos, trusts can be used to achieve one’s estate planning goals.
What is a living trust?
To set up a living trust, the trust founder will enter into a contract with the trustees in the form of a trust deed in terms of which he will make an initial donation to the trust in order to set up the trust. The trust is governed by a trust deed which provides a mandate to the trustees on how the assets should be managed on behalf of the trust beneficiaries. In general, this type of trust can be used to provide for the living costs, ongoing care, maintenance, education, and/or medical needs of the beneficiaries, or to transfer assets to the capital beneficiaries on the termination of the trust.
Who are the parties to the trust?
There are essentially three parties involved in setting up a living trust. The trust founder, also known as the settlor or donor, is the person who initiates the trust and who donates the property to the trust. The trustees, appointed by the trust founder, are custodians of the assets held in the trust although they do not necessarily have an interest in the assets. The beneficiaries of the trust are those individuals or entities who benefit from the trust’s assets and/or income.
What type of assets can be held in a living trust?
The founder can transfer assets to a living trust by either selling the asset to the trust via a loan account or by donating assets to the trust. A tax-efficient way of achieving this is to direct one’s annual R100 000 donations tax exemption to the trust. Assets that can be held in trust include land or immoveable property, investments, cash, collectibles, or jewellery, all of which are generally referred to as the trust capital.
What is the difference between a discretionary trust and a vesting trust?
A living trust can either be set up as a vesting or discretionary trust depending on the intentions of the trust founder. In a vesting trust, the named beneficiaries have a right to receive certain benefits while the benefits that flow from the assets are managed by the trustees. In the more commonly used discretionary trust, the trustees are able to use their discretion to determine how the benefits of the trust are distributed to the beneficiaries. A discretionary trust provides the trustees with a mandate to manage the trust assets in the best interest of the beneficiaries, making it a flexible and effective vehicle for protecting and managing assets. Using their discretion, the trustees can make decisions as and when circumstances, legislation, and fortunes change.
Are trust assets protected from creditors?
Living trusts can be used effectively to protect assets from potential creditors although it is important that the trust is correctly set up. Where the trust founder fails to relinquish control of the assets and either continues to treat the trust property as his own or unduly influences the trustees to act on his behalf when managing the trust asset, it may be found to be what is known as an alter ego trust. This is often the case in acrimonious divorces where one party wishes to hide assets from the other but does not wish to relinquish control of the assets. A trust can be considered a sham if the intentions of the trust founder and the trustees are not in line with the requirements of a valid trust. If the courts establish that the requirements for a valid trust have not been met, they can rule that the trust is void from inception, including all transactions that took place.
What is estate pegging?
Living trusts can be used effectively to house growth assets outside of one’s personal estate to reduce tax and estate duty liabilities, a process that is often referred to as estate pegging. For instance, if an estate planner wants to purchase a holiday home, he may choose to house the property in a living trust using a loan account. The value of the loan account will be pegged at the current value of the holiday home while all growth in the value of the property will take place in the trust, thereby reducing the estate duty liability of the estate planner.
Can living trusts be used for succession purposes?
One of the most significant advantages of a living trust is that it survives the life of the trust founder and, as such, can span across multiple generations, ensuring continuity and allowing for seamless succession. This is because living trusts allow for assets to pass through successive generations without falling into the individual estates of family members who have passed away. In the event of the trust founder’s death, the assets held in trust will not form part of the estate administration process and can be used to provide beneficiaries with ongoing access to funds after the founder’s passing.
How are trusts taxed?
Our law recognises trusts as taxpayers and, as such, living trusts are liable for both income tax and capital gains tax. In respect of income tax, trusts are taxed at a flat rate of 45%, whereas special trusts are taxed at a sliding scale from 18% to 45% (as per individuals). If correctly set up, an inter vivos trust can be administered to mitigate estate duty, income tax, CGT, donations tax, and transfer duty. Upon the founder’s death, the assets held in trust will not be liable for estate duty, executor’s fees, or CGT.
How can a living trust benefit a disabled beneficiary?
Depending on the circumstances of the founder, a trust can be used to centralise and control assets on behalf of beneficiaries who are unable to do so themselves, such as in the case of a mentally or physically handicapped child. Where an inter vivos trust is used to provide for a beneficiary who is physically or mentally disabled, it can qualify as a special trust in which case it will be taxed as an individual and qualifies for other tax concessions.
Are there disadvantages to setting up a living trust?
There are a couple of potential drawbacks which should be considered before setting up a trust. Firstly, trusts can be administratively intensive as they involve preparing annual financial statements, filing of income tax returns, ongoing record-keeping, preparation of minutes and trust resolutions, running a separate bank account for trust cash flows, and the maintenance of an asset register – keeping in mind that there are inevitably costs involved. Another factor to bear in mind is that the trust founder must relinquish control of the assets which means that those assets no longer belong to him. With this in mind, the trust founder must be absolutely certain that he can afford not to have those assets in his personal estate.
In closing, bear in mind that living trusts can be useful to those whose personal estates have values in excess of R3.5 million and who have growth assets that they wish to protect for future beneficiaries. However, not everyone will benefit from a living trust and it is advisable to seek the advice of a trust expert before deciding whether or not to form a trust.
Have a fantastic day.
Sue
