How to create a trust fund for your children
This guide explains what a trust is, how they function and the benefits of investing in one.
What is a trust fund?
There are two types of trusts that a person can set up. These are an inter vivos trust, also known as a living trust, and a testamentary trust.
Izak Strauss, a business and life coach with experience in the legal industry explained: “An inter vivos trust is set up while you are still alive. [A] testamentary trust is established upon your death, usually as part of your will.”
Ragiema Thokan-Mahomed, legal manager at the South African Institute of Professional Accountants (SAIPA) said: “Most people include a trust in their last will and testament which relates to all amounts that their children inherit. This is done to ensure that money is not squandered and the general clause usually permits access to the funds upon attaining the age of 25 or as stated.
“Trustees are nominated to protect the assets of the trust and re-invest trust funds on behalf of the beneficiaries. It’s best that an attorney is approached to draft the document as the trust can stand as a legal entity and is capable of being sued.”
Hill noted: “A testamentary trust is probably the most common type of trust. The testamentary trust is simply a couple of clauses in the will where you say, “I appoint the following person as a trustee”, and that person, if the master of the high court grants them authority, can officially act as a trustee. A testamentary trust costs you nothing to set up, but it’s a very effective tool.
“Not everybody has a lot of assets that they need to protect in their lifetime, but when they die, very often they are worth more dead than alive because insurance policies pay out and there is more money.”
Hills revealed that because a life insurance policy is entered into prior to death, you appoint the beneficiaries of the policy in the beneficiary nomination form, which is also where you nominate your testamentary trust. “It is protected if it’s in the trust that is the big benefit. That’s a trust in the will, and for most people that is the most important trust that they will ever establish is in the will.”
Inter vivos trusts
An inter vivos trust, or living trust, can pay out while the founder is still alive. Hill explained that with this type of trust, the founder can also be a beneficiary of the trust. He added that these types of trusts are usually quite flexible, as people want access to their money when they need and don’t want to have to wait.
Investing in a trust
Hill points out that when investing in a trust, you don’t actually give or donate your money to the trust, but rather you lend it to the trust. This means that the amount you give will be exempt from donations tax, as you can get the money back at any point when you need it. However, this amount will be interest free.
The interest earned on the amount that you donate to the trust will remain in the trust to be paid out to the beneficiaries, as stated in the trust deed. Hill says: “The trust deed is a tailor made agreement. You can put what you like in it, so you might have a particular programme for your family that you want to be paid out when the child starts university or turns 21 or starts a business, so you can protect your family as best you see fit.”
The trust deed can be a flexible or as strict as the founder sees fit. For example, if the trust deed states that the funds must be used to pay for your child’s tertiary education, but your child decides not to go to university, the trustees will have the ability to determine what the money should then be used for, such as buying a car for work purposes.
According to Hill, investing in a trust also has the benefit of protecting your money in the event of you going bankrupt or insolvent. This is possible because only the amount that you donated to the trust to begin with can be claimed by the creditors. The interest and growth that was earned on that initial investment belongs to the trust and therefore cannot be claimed to pay your debts.
There must be at least three trustees for a trust to ensure that all decisions that are made regarding the trust are in the best interest of the beneficiaries and that one person cannot dictate what happens with the funds. This is particularly important because a trustee can also be a beneficiary, and they must not unduly benefit from the trust.
Strauss clarifies: “The trust “fund” which is referred to are the actual assets that are donated or transferred to the trust by the founder. So technically all the property in the trust is known as the trust fund. You therefore do not set up a trust fund, you set up a trust. The trust is the legal entity that holds the assets for the benefit of the [beneficiaries].”
Why do people set up trust funds?
According to Strauss, one of the main reasons that people set up trusts is that parents are wanting to ensure that their children will be financially looked after in the event of their death (or the death of the founder).
Another reason is to take control of the assets away from the beneficiaries or children. There are many reasons why this may be necessary, for example, a beneficiary has problems with addiction or is unable to care and make decisions for themselves due to a disability. The beneficiaries may also be minors, and therefore be unable to manage their own affairs.
A parent may also establish a trust for their children so that in the event of their death, if their spouse remarries, the new husband or wife will not have access to the money and it will be used for its intended purpose.
Strauss elaborates: “The assets will be managed by the appointed Trustees. The children or family will be income or capital beneficiaries, but the assets will never be under their control or their property… The trustees need to act in their discretion and make distributions of income or capital to the beneficiaries according to their needs.”
How to set up a trust fund
“The founding (trust) documents must be carefully drafted by a qualified attorney or accountant according to the needs of the founder. [This] will be submitted to the Master of the High Court in the specific province and a Letter of Authority will be issued which enables the trustees to act on behalf of the trust,” explained Strauss.
There are three main parties involved with the trust. These are the founder who establishes the trust, the beneficiaries for whom the trust has been established, and the trustees who manage the trust’s assets on behalf of the beneficiaries.
Taxes and trust funds
Hill stressed that it is not possible to avoid paying tax, even with a trust fund. If the beneficiaries are not liable for tax because they are minors (or any other reason), the trust or the founder will be responsible for paying the tax.
Strauss says a trust is liable for income tax of 41% and capital gains tax of 26% on any assets sold.
But estate duty will not apply to a trust. “A trust is set up outside your estate, so the assets belong to the trust and not your personal estate,” says Hill.
However, if someone has a claim against the loan that was made to the trust, that is still an asset within the estate, and if the claim is more than R3 500 000 then there could be estate duty on the loan amount.
Hill highlighted that if your estate is less than R3 500 000 it is free from estate duty, however, any amount above that will be liable for estate duty.
Strauss added: “Should an individual pass away, s/he will be liable for estate duty at a rate of 20%, if the value of the estate is above R3 500 000. Individuals are therefore exempt for the first R3 500 000. If your assets are in a trust, however, no estate duty will be payable, as the assets do not form part of your estate.
“The only tax that will be payable after your passing is when distributions are made to beneficiaries. The beneficiaries will be liable for income tax in their respective tax brackets upon receiving income from the trust, or capital gains tax upon receiving assets such as shares or property.”
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