Trusts are commonly used to ‘freeze’ the value of assets, so that when the person who transferred them to the trust dies, they won’t form part of his/her deceased estate.
Usually, an owner will sell his/her assets to a trust. The amount of the purchase price payable by the trust might continue to appear as a liability (debt) in the books of the trust and a corresponding asset in the seller’s books, but any growth in the asset belongs to the trust. The effect is to reduce the dutiable estate of the seller over time, and hence the estate duty arising upon his/her death. If estate duty is reduced, the heirs will receive a larger inheritance.
There are several important reasons for the ongoing use of trusts as part of holistic financial planning:
1. Trusts offer protection against other types of tax
Even if estate duty were to be abolished, trusts still offer tax advantages, though usually not in the short term, owing to the deeming provisions of the Income Tax Act.
Once the deeming provisions no longer apply, tax savings might be available. For example, income can be distributed to trust beneficiaries who might well be in lower tax brackets than the original owner of the assets. Capital gains can likewise be distributed to such beneficiaries.
Furthermore, if the trustees do not wish that the beneficiaries use the cash immediately (for various reasons), income and gains can be vested in such beneficiaries and physical payment made later, for example, at a time when they reach an age of understanding, or the monies are needed to fund education.
2. Trusts can reduce the costs of winding up a deceased estate
Executor’s fees and other winding up costs can eat into the limited pool of available cash in an estate. Since trusts do not die, such costs simply do not arise.
3. Trusts offer protection against the uncertainties of life
Trusts not only offer protection against certain taxes levied at the time of death, but more importantly, against claims arising against a personal owner of assets during his/her lifetime.
At death, compensation in the form of life assurance proceeds is usually available, but during life, a large claim against one’s estate, possibly leading to personal sequestration, results in no such assurance compensation.
It is bad enough to lose one’s business, but to reward one’s creditors with one’s house, motor vehicles and investments shows a poor appreciation of risk management. It is also the sad result of an obstinate disregard of the benefits of available professional services. Many people are so busy working to create wealth that they fail to use such services and end up losing much of the fruit of their labours. Often a simple action can result in substantial benefits.
4. Trusts offer protection against the uncertainties of death
During one’s lifetime one can try to educate family members about good financial practices and discipline. Premature death would frustrate such efforts. Even educated people can come under the sway of others, who may be well-meaning, but do not have an understanding of the bigger picture or the longer term horizon.
Trustees who are skilled in such matters can materially enhance the long-term financial well-being of current and future generations.
5. Trusts can buy time
Most business people and investors wish to make commercial decisions in their own time and not according to the timescale of the Master of the High Court. The Master is tasked under the Administration of Estates Act with overseeing the winding up process of deceased estates in his area of jurisdiction.
An executor’s sole aim is to achieve the 100% pass mark required by the law in the submission of the prescribed accounts to the Master. The executor has to attend to a host of administrative requirements, all on a strict timetable, deviations from which require prior written permission, given only upon cogent reasons submitted.
During this winding up process, which can take 6-8 months (or longer), a business owned personally by the deceased, or a company of which he was the sole director, is at risk. In such circumstances, normal commercial decision-making is suspended, which can lead to customer shrinkage and a drop in the value of business assets.
Indeed, if the executor has good reason to think that by allowing such a business to continue running after the death of the owner, its value might shrink by a significant amount, he is obliged to liquidate the business sooner rather than later. His risk profile is different from that of a business person who is used to taking commercial risk. It is better for such a business to be owned by a company, which is in turn owned by a trust. Decisions are then made by the director(s). Should all directors die, or become unable to run the company, the shareholder, that is, the trust, represented by the trustees, has the responsibility to appoint alternative directors to ensure continuity of commercial decision making.
6. Trusts can mitigate or avoid the common shortfalls in cash in a deceased estate
Certain people are said to be “worth more dead than alive” (usually due to life assurance proceeds). It is equally true that many people “owe more dead than alive”.
Most estates have more debts than cash (often due to taxes which arise only at point of death) and usually the executor has to sell assets to raise cash. The timing of a sale is not a luxury available to the executor and so, quite often, valuable assets realise far less on a forced sale than they would under normal circumstances. This means that even more assets have to be sold (again at lower prices) to make up the shortfall, leading to a vicious circle.
It makes more sense to reduce one’s personal assets and liabilities to manageable proportions, while building up trust assets which the trustees can continue to manage after one’s death, unconstrained by legislated timetables.
7. Trusts permit ‘one owner, many users’
Certain assets intended to be used by different family members, especially those needing constant upkeep such as holiday houses or large boats, lend themselves to trust ownership. Management, registration, accounting, expense and financial records can be centralised, thus saving costs, while trust beneficiaries can enjoy the pleasures of ownership on an equitable basis.
Since a trust is a contract between the founder and the trustees for the benefit of beneficiaries, it is necessary to tailor make it to one’s particular financial and domestic circumstances. Trustees need to understand their fiduciary responsibilities and have a comprehensive appreciation of the deeming provisions of the Income Tax Act. Professional consultation is, in this regard, not a luxury, but a necessity to ensure that one’s affairs are properly structured to avoid any attacks by creditors or others.
*Clive Hill, estate planning specialist, Glacier by Sanlam