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THE USE OF TRUSTS IN ESTATE PLANNING
Financial planners should realize that trusts still form part and should be included in a variety of holistic estate planning disciplines when giving advice to clients. The use of trusts as a planning tool in estate and financial planning is as relevant and important as ever. If structured and administered properly, it remains the most comprehensive estate planning vehicle.
If the primary goal is to get instant gratification from the estate planning exercise or to save tax and estate duty over the short term, then a trust is not the answer.
With SARS bringing capital gains tax (CGT) and normal tax closer to one another, the result is that all taxes are becoming similar; except CGT for individuals.
In an individual’s estate, however, death will trigger double tax with both CGT (18%) and estate duty tax (20%), as well as executor’s fees of 3,50% (VAT exclusive) on gross assets (NOT on nett assets after debt). This often results in executors having to sell assets to pay for those taxes upon death.
Unlike in an individual’s case, a trust will only incur CGT (36%) upon the ACTUAL SALE OF AN ASSET and is not linked to the demise of any one individual.
Two benefits that are only applicable on trusts are the conduit principal and income splitting. These tools can be utilized to distribute capital gains to beneficiaries with lower tax rates; therefore, utilizing the lower tax rate applicable to individuals - BUT be mindful of the death taxes described above after such a distribution!
The Conduit Principal
Unlike in companies or close corporations, the trustees of a trust can decide to pay income tax (45%) or CGT (36%) in the hands of the trust or to distribute the tax liability to the beneficiaries at their marginal rate of tax. Thus, the conduit principal is that trust income or capital that has vested in beneficiaries is not taxed in the hands of the trust, but rather in the hands of the beneficiaries, based on their own personal income tax rates and no tax will be payable by the trust on those amounts.
Trustees can also use the conduit principal and pay beneficiaries who do not earn enough to pay tax. Trust income can be split between beneficiaries who earn up to this threshold and end up paying no, to very little tax in their personal capacities.,
A company can also be used to hold assets that produce income to make use of the lower effective tax rate on income (42,2%) versus a trust (45%), without using the possible advantage of the conduit principal or income splitting discussed above. The increase in the dividend tax rate from 15% to 20% however, elevated the effective tax on capital gains for companies to 27,92% versus 36% for trusts. So, unless such gains are retained in the company, higher taxes will be paid on capital gains made in the company, which are distributed as a dividend to a trust as shareholder in the company or to the owner (exposing such cash to creditors and death taxes).
If structured and administered properly, it still is the most comprehensive estate planning vehicle for the following reasons:
Always be mindful of the introduction of the new Section 7C in the Income Tax Act that now taxes interest-free loans to trusts and companies owned by a trust by including the difference between the minimum set interest at a rate of 8% per annum and the actual rate charges (historically often 0%) on such loans as an annual donation (taxed at 0%) to the trust. The annual tax-free R100 000 donation allowance can however, be set off against this calculation.
Having said that, do not be fooled. Government made it very clear that they will tax historical wealth and have now, for the first time, introduced a wealth tax. It does not matter where this wealth is kept: in a personal name, in an entity such as a company or close corporation or in a trust. Trusts are not the only target for SARS and trusts still have structuring benefits to minimize tax, unlike any other taxpayer.
Remind your clients of the reasons why they created a trust in the first place, reasons such as asset protection, continuity, liquidity, etc. The main reason should never have been to avoid tax, although trusts do provide mechanisms to optimize taxation.
Even if the tax and estate duty benefits in the long term are ignored, the asset protection benefits of a trust remain significant. A trust is certainly not only for the wealthy. If a client is financially vulnerable, the protection of assets should be looked at. A trust is the only vehicle that offers total asset protection. This is achieved through a trust not being owned by anyone and, as mentioned before, not being able to die.
Professional advice should always be acquired when dealing with trusts. Laws govern the dealings of a trust and these change from time to time. There are pitfalls that should be avoided and quite a few things to consider in the planning of a trust.
Main source: EM de Vos, Trust Manager, Legatus Trust - firstname.lastname@example.org
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