Clive Hill, legal adviser at Discovery Life, explains that a trust is a contract entered into by a person (the founder of the trust) and the chosen trustees.
“It is an agreement or a contract that can apply while you’re alive, or you can make it part of your will. The latter is a very common form of trust for parents,” Hill says.
This article explains what a trust is, how it functions, and the benefits of creating one.
What is a trust ?
There are two types of trusts that a person can set up. These are an inter vivos (or living) trust, and a testamentary trust.
Izak Strauss, a business and life coach with experience in the legal industry, explains, “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 Samsodien, independent contractor at IIE MSA, says, “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 reinvest trust funds on behalf of the beneficiaries. It’s best for an attorney to draft the document, as the trust can stand as a legal entity and is capable of being sued.”
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Testamentary trusts
Hill notes, “A testamentary trust is probably the most common type of trust. This is simply a couple of clauses in a will where you say, ‘I appoint the following person as a trustee’, and that person, if granted authority by the master of the High Court, can officially act in that capacity. 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,” Hill continues. “However, when they die, very often they are worth a great deal, because of their life insurance."
Hills notes that both trusts and beneficiaries are noted on a beneficiary nomination form.
“The policy proceeds are protected if paid out to the trust, which is a big benefit. For most people, the most important trust that they will ever establish is in their will.”
Inter vivos trusts
An inter vivos trust, or living trust, can pay out while the founder is still alive. Hill explains that with this type of trust, the founder can also be a beneficiary.
He adds that living trusts are usually quite flexible, allowing both founders and beneficiaries to access the money when the need arises, not only after the death of the founder, as would be the case with a testamentary or will trust.
Investing in a trust
Hill points out that when investing in a trust, you don’t actually give or donate your money, but rather, you lend it to the trust. This means that the amount you give will be exempt from donations tax when you access it, as long as you have charged the trust interest on your contribution.
The interest or capital growth earned on the amount that you donate 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 you see fit.”
The trust deed can be as flexible or as strict as the founder wishes. For example, if the trust deed states that the funds must be used to pay for a child’s tertiary education, but the child decides not to go to university, the trustees have the ability to determine a suitable use for the money, such as buying the child a car for work purposes.
According to Hill, investing in a trust also has the benefit of partially protecting your money in the event of bankruptcy or insolvency. Only the amount that you donate can be claimed by your creditors. The interest and growth earned on the investment belong to the trust, and therefore cannot be claimed to pay your debts.
There must be at least three trustees to ensure that all decisions that are made regarding the trust are in the best interest of the beneficiaries. This prevents a single person from dictating 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 adds a point of clarification on terminology. “A trust ‘fund’ consists of 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. Thus, you don't 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 trusts?
According to Strauss, one of the main reasons people set up trusts is that parents want 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 seize control of the assets from the beneficiaries or children. There are many reasons why this may be necessary, for example, a beneficiary has an addiction problem, or is unable to make important decisions due to a disability. The beneficiaries may also be minors, and therefore 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 at their discretion and make distributions of income or capital to the beneficiaries according to their needs.”
How to set up a trust
Strauss says, “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.”
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 trusts
Hill stresses that it is not possible to avoid paying tax, even with a trust. If the beneficiaries are not liable for tax because they are minors (or for any other reason), the trust or the founder will be responsible for paying the tax.
Hill says a trust is liable for income tax of 45% if the income is not distributed to beneficiaries, or is not regarded as the founder’s income. It is liable for capital gains tax of 36% on any capital gains made when trust assets are sold. However, the gains are not distributed to beneficiaries or attributed to the founder.
If income or gains are distributed to beneficiaries or attributed to the founder, then those beneficiaries or the founder will pay tax at their personal tax rate. Consulting a tax practitioner is highly recommended to ensure proper disclosure is made in the trust’s tax returns each year.
Estate duties are an area that requires specific management. If a founder has a claim against a 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.
Strauss notes, “Should an individual pass away, estate duty will be due 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.
He continues, “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, or money which came from a capital gain made by the trust.”
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