Robert Kiyosaki, author of ‘Rich Dad Poor Dad’ fame, said: ‘It’s not how much money you make, but how much you keep, how hard it works for you, and how many generations you keep it for.’
Managing our finances and investing our hard-earned cash often involves some of the most difficult choices and decisions, especially when we plan for retirement or for providing for the loved ones we will one day leave behind. Effective tax and estate planning are synonymous with this.
The many options, instruments and investment vehicles that are available can be quite bewildering and should ideally be investigated with the help of an expert, reliable, independent financial adviser. Among these options are Qualifying Recognised Overseas Pension Schemes (QROPS) for those who have a UK pension; fiduciary structures such as discretionary trusts or self-invested personal pensions (SIPPS), and many other different types of trusts.
Among the many types of trusts are discretionary trusts, probates trusts, interest in possession trusts, charitable trusts, accumulation-in-maintenance trusts, pension trusts and special purpose trusts. Among discretionary trusts alone the options tailored to your goals are many, all differently focused and structured, each having to comply with specific legal and other requirements. You may have a single trust in which to house all your assets, or you may have multiple trusts which often are unnecessary. Discretionary trusts are ideal for inheritances.
Many South Africans are familiar with what is commonly referred to as a ‘family trust’, which has many features of a discretionary trust. There are also excellent options available in respect of offshore trusts and international retirement plans. These offer different advantages, but also require awareness of different laws, tax systems and other implications.
Mike Fannin, Group Sales Director for Carrick Wealth and an expert in trusts and sustainable retirement solutions, compares the setting up of a trust to climbing a mountain: you have to know how high it is, where you want to go, and how you will get there. The key, says Mike, is that given the many options available, you and your independent financial adviser (IFA) should be very clear on your specific requirements and be well informed about all relevant aspects and issues before deciding on the appropriate holding structure for your investments. To do otherwise could have disastrous consequences.
What exactly is a trust?
Trusts are widely used as a well-established way of protecting and enhancing a family’s wealth and ensuring the safe and efficient passing on of such wealth to a specified class of beneficiaries. This may typically include future generations of the family, a surviving spouse, or the heirs of the one setting up the trust.
Modern trusts have their origin in medieval England when a knight went off on crusades and would leave assets in the care of a ‘trusted person’ to make sure his wife and children would inherit them should he be killed. Over time the concept, as it became more formalised, developed differently in different countries and disparity in legislation and governing rules set in across different countries.
While there are many different types of trusts, the discretionary trust is most common today. It is effectively and widely used for international financial and estate planning.
A discretionary trust is where the person setting up the trust places discretion of the administering of the trust in the hands of others – the trustees. However, he or she can determine who should benefit from the trust, when and how, binding the trustees to his/her wishes. In South Africa, trusts are regulated by the Trust Property Control Act 57 of 1988 and do not have an independent legal personality except in certain circumstances, such as for tax and insolvency purposes. The primary legal focus is that the assets in the trust have to be protected at all times and to this end the Trust Property Control Act requires trust assets to be kept separate from trustees’ personal assets.
Trusts are viewed by tax authorities as separate tax entities. However, they can provide substantial tax benefits if set up and managed correctly. In most instances they offer protection of the assets in them against the personal legal liabilities of the person who sets up the trust or against claims against the estate of that person.
Parties to a trust
The Settlor (or Founder) – is the person (or persons) who sets up the trust, and donates or lends assets to the trust.
The Trustees – are the appointed legal owners of the assets in the trust who have to administer it in compliance with the trust deed, the prevailing trust laws and tax requirements, as well as with the so-called letter of wishes, if there is one.
The Beneficiaries – are the persons who are entitled to receive benefits from the trust. The settlor may also be a beneficiary; and the beneficiaries and their specific benefit may be specified or not, with the trustees given discretion in the latter instance.
The Protector – can be appointed optionally by the settlor to ensure that the trustees are doing their job correctly and carrying out the wishes of the settlor; however, this can sometimes create conflicts of interest and could, under certain conditions, adversely affect the tax status of the trust and the settlor.
Creating a trust
Rex Cowley of Overseas Trusts and Pensions and a trust advisor to Carrick Wealth explains that the trustees legally own the assets within the trust but can derive no benefit from them other than the agreed-upon fee paid to them for administering the trust. The trustees have to ensure that the assets are used only for the benefit of the the beneficiaries; they cannot derive a profit for themselves from the assets; the trustees’ creditors have no claim against the assets; and the trustees are obliged to act at all times in the best interest of the beneficiaries.
Setting up a trust in South Africa is quite simple and involves the drawing up of an agreement, known as the ‘trust deed’, which has to be registered with the Master of the High Court. Apart from registering the trust, the Master of the High Court oversees and controls the appointment of trustees. The Master has to be notified if any of the trustees are changed and exercises supervision over the appointment of trustees. The Master may call trustees to account about the administration of trust property. In practice, however, this supervision is generally limited and most often the Master will only exercise oversight when a complaint is lodged. In such cases, the Master may inspect the financial statements of the trust, may require additional information, and may even decide to remove a trustee from the board of trustees.
In some other countries trusts may be more rigorously regulated and may have to comply with further legal requirements.
The settlor nominates the trustees and, in addition to the trust deed, the settlor may issue a ‘letter of wishes’. This letter sets out how the settlor’s wishes should be carried out by the trustees, or how the settler wants the trustees to use their discretion regarding the use of assets and distribution of benefits of the trust. The letter of wishes does not form part of the trust deed and is not a legally binding document, unlike the trust deed.
The assets in the trust do not form part of the estate of the settlor. Therefore, upon the death of the settlor the trustees continue administering and utilising the assets for the benefit of the nominated beneficiaries without there having to be lengthy and expensive procedures of winding up a deceased estate and distribution of assets left under a will.
The trust can be set up as ‘revocable’ or ‘irrevocable’: it can have named or unnamed beneficiaries, and there can be vested or unvested beneficiaries (the beneficiary is named and his/her portion of the benefits is stipulated). Under certain conditions the trust may own foreign assets, but, in general, it will not have the same foreign exchange allowance as an individual. When the trust has no more assets left, it becomes dissolved unless the beneficiaries indicate to the trustees that they want to add new assets to it.
In South Africa, as in many other countries, the trustees can be sued, but not the trust, and therefore the assets are protected. Where it is found that the settlor continues to exercise influence or control over the assets and how they are utilised and the trustees are not able to use their discretion, the trust will become void as the settlor is deemed to have never given up ownership of his/her assets. Also, if it can be proved that a trust was set up to avoid a personal liability – for instance, because of a pending divorce or debt recovery – the trust could become void.
Asset protection, succession planning and tax efficiency to a point would be good reasons for setting up trusts. However, administering a trust has a cost to it and as much as 2 per cent of the asset values of trusts could be paid towards that on top of taxes payable.
While care should be taken as to different tax requirements and rules in different jurisdictions, trusts, if correctly structured, generally lessen or even exclude the liability of the settlor and beneficiaries in respect of income tax, capital gains tax or estate tax.
Because trusts were such tax efficient structures, they were frequently abused for tax avoidance in the past. The tax authorities in South Africa – and in many other countries – consequently started tightening up tax laws applying to trusts. Today the flow-through or conduit principle applies to trusts in many countries.
In South Africa, for instance, when dividends are distributed to the beneficiaries from shareholdings held by the trust, or interest earned on investments held by the trust is paid to beneficiaries, the beneficiaries will be liable for paying dividend or income tax respectively – the latter at the beneficiary’s personal tax rate. If the dividends or interest remain in the trust, the trust will be taxed at the much higher tax rate. Non-taxpayers such as minors are exempt. Charitable and other special purpose trusts that are clearly defined for a specific purpose enjoy various tax exemptions.
However, as inheritance tax in South Africa is 20 per cent – and even higher in some other countries – moving his/her assets into a trust will save the settlor this expense upon death. For someone who puts R100-million into a trust, that is a saving of R20-million.
Another tax issue concerns the assets the settlor donates (gifts to) or lends to the trust. After a certain minimum value such donations are subject to a 20 per cent donation tax.
‘The loan serves as little more than a long-term deferral of tax liability,’ Rex points out.
South African ‘family trusts’
As already mentioned, many South Africans are familiar with the concept of a discretionary trust most commonly referred to locally as a ‘family trust’. According to Rex, the domestic trust industry is a very large one and there are various different types of trusts for different purposes to choose from.
But the majority of trusts established in South Africa are set up either as pension-providing trusts – where the beneficiary can only access the assets after a certain lapse of time – or as family trusts set up as a family affair with assets such as fixed properties and investment portfolios for inheritance and maintenance purposes. A major consideration with South African family trusts is that such a trust does not attract estate duty on the death of the settlor because the trust owns the assets. From that point of view a trust can be advantageous.
But, as pointed out, discretionary trusts in South Africa generally are no longer very tax efficient vehicles – one of the three parties involved will always be paying the taxes.
There are also various special purpose trusts such as a charitable trust set up to fund charities, or a trust set up specifically for the benefit of a disabled child, or trusts that disperse bursaries to deserving persons for study purposes such as, for example, the well-known Mandela Rhodes Scholarships.
Offshore trusts and international retirement plans
For high-net-worth individuals offshore trusts and international retirement plans are excellent options to consider. They offer excellent wealth consolidation options in a secure environment protected against currency erosion and political or economic shocks and are also ideal for people living in countries with restrictive exchange controls. However, again sound knowledge and expertise about the different structures that are available are indispensable as there are many legal and tax implications. This is an area in which Carrick provides expert services and advice.
Read more about these options in our next section, ‘Finding security in offshore trusts and international retirement plans’.
- For more information and advice on trusts and international retirement plans, call Carrick Wealth on +27 21 201 1000.
— Carrick Wealth (@CarrickWealth) August 25, 2015