By Roz Wrottesley
This article was first published in the third-quarter 2014 edition of Personal Finance magazine.
A testamentary trust (also known as a will trust) comes into being after the death of the testator, because the trust clauses are contained in the will. The main purpose of such a trust is to protect the assets in the estate for (and sometimes from) the beneficiaries. As with all trusts, a testamentary trust is a means of transferring assets into a separate protective “vehicle” (a trust is not a separate legal entity, except for tax purposes) that is administered by trustees for the benefit of one or more beneficiaries.
You might have minor children who require financial support until they are old enough to inherit assets in their own right; or adult beneficiaries who lack the mental capacity to look after their affairs, or whose lifestyles make you doubt their competence to manage assets left to them. In an era of multiple marriages and partners, you might want to give your present partner access to your assets in his or her lifetime but ensure that, ultimately, they are preserved for your children from a previous relationship.
The will itself acts as the trust deed, so it is likely to be a longer, more complex document than an ordinary will, spelling out your wishes and naming the people appointed to act on your behalf in the interests of your beneficiaries. They are the trustees – distinct from the executor(s) of your estate and with a much longer and potentially more complicated commitment. Appointing trustees is often done lightly, like bestowing an honour on a relative or friend, with no real appreciation of how onerous the responsibilities can be.
According to the Trust Property Control Act 57 of 1988, “a trustee shall, in the performance of his duties and the exercise of his powers, act with the care, diligence and skill which can reasonably be expected of a person who manages the affairs of another”. And there is no way of reducing that responsibility. As the Act puts it sternly: “Any provision contained in a trust instrument shall be void in so far as it would have the effect of exempting a trustee from or indemnifying him against liability for breach of trust where he fails to show the degree of care, diligence and skill as required [above].”
So you might appoint as trustees your brother, who lives in another city, is an accountant and has a good relationship with your children; your partner of the past 10 years who knows you best; and – if you follow best practice – someone who knows the law – possibly, but not necessarily, the legal adviser who helped you to draw up your will. Three trustees who bring three different perspectives to the table is the generally recommended number, Laurianne Hollings, a wills and estates specialist with Hollings Attorneys, says.
Many people do not appoint as many as three trustees and do not include anyone with an understanding of the role, because they never fully appreciate how unpredictable and complicated life can be, Hollings says.
The trustees should generally be granted very wide powers, to ensure that they have the freedom to act in the interests of the beneficiaries in all circumstances. But the task of balancing conflicting interests and taking tough decisions can be too much for a single trustee, or trustees without a thorough grasp of the trust’s purpose and their precise duties.
On the other hand, Johann Jacobs, the national practice head of the trusts and estates department at law firm DLA Cliffe Decker Hofmeyr, says he recommends as few trustees as possible, for practical reasons, and puts the emphasis on choosing wisely. Dealing with regulatory requirements and government departments can become very cumbersome when there are a number of trustees and they are not located in the same place, he says.
“Government departments are less and less likely to accept that one trustee has been authorised by other trustees to, for example, sign documents on their behalf. That can cause complications and delays. You have to balance that with the fact that you may not want to put all the power in one person’s hands. So you could appoint a layperson – who would be someone who knows the family well – and a professional person who understands the responsibilities of trustees,” Jacobs says.
Whatever the intention of the deceased, the trustees’ powers are only as far-reaching as they are allowed to be by the wording of the will – and the wording cannot be changed without a costly court application.
Whereas an inter vivos trust (a trust that comes into existence during the life of the founder – see “Definitions”, below) can be amended or terminated, a testamentary trust is cast in stone at the moment of the founder’s death, when it comes into being, and everyone has to live with the consequences. It terminates when the founder intended it to and no sooner – which might be once all the assets have been distributed, or upon the death of a spouse, partner or other beneficiary.
Purposes of a testamentary trust
A testamentary trust is a valuable tool when you need to look after people who are not ready or able to look after themselves.
Minor children (under the age of 18) .
Any money inherited by a minor must be paid into the Guardian’s Fund, under the jurisdiction of the Master of the High Court, until the beneficiary turns 18 (or a later age specified in the will). The money is invested by the Public Investment Commission, and interest is paid on it, but claiming money for the beneficiary’s expenses can be cumbersome.
You can leave property to a minor, but cash would be required to maintain the property. A minor can also not sell a property should it become necessary to do so.
By setting up a trust, you can avoid having money for a minor paid into the Guardian’s Fund and instead assign the responsibility for property and for managing your money and any other assets according to your wishes to the trustee(s). The trustees are guided by the terms of the will; for example, it might specify that the child’s guardian be paid an income for the benefit of the child every year, increasing at the rate of inflation, and that the trust pays all education and medical expenses, plus any unforeseen expenses within reason, until the beneficiary is aged 25, when he or she should receive the remaining income and all the capital.
Chris Murphy, a director at Legacy Fiduciary Services & Estate Planning and the chairperson of the Fiduciary Institute of Southern Africa (Fisa) in the Western Cape, believes the roles of guardian and trustee should be separated, with the guardian looking after the day-to-day care of a minor child and the trustee(s) taking care of the finances.
“If you are responsible for a child’s everyday well-being, you probably don’t have time to make sure the capital in the trust provides for the child properly and remains 100-percent secure. The task of a trustee is to keep everything in abeyance until the child reaches the right age, ensuring that the wishes of the testator and the terms of the trust are adhered to formally, financially and correctly,” Murphy says.
The age at which a minor beneficiary should receive the capital and any accumulated income could be 18, 21, or anything else, but the current trend is to choose 25.
He says: “The theory is that you leave school at 18, then you go into some form of further tertiary education or training. You get your degree or diploma – hopefully, after only a couple of failures – at 23. You’ve then got two years to do articles or an internship, and by age 25 you’ve done what you are going to do, learned what you need to learn, and receiving the capital at the more mature age will help you set up in business or buy a home. And away you go.
“Although,” he laughs, “we have seen a case where the client wanted her daughter to receive the capital from the trust at age 85. She said that, by that age, her daughter’s ‘bloody husband’ would be dead, and she would be happy for her to have the money only once he was gone.”
If your assets do not include a home and are confined mainly to cash from a retirement fund, there is an alternative to a setting up a trust – you can ask the trustees of your retirement fund to consider putting the money in a beneficiary fund that is regulated under the Pension Funds Act. The trustees of these umbrella funds manage the benefits of many fund members, but your money will be in an sub-account for the benefit of your beneficiaries and the trustees can pay a guardian for costs, such as the education of a child. When the child turns 18, the money can be paid out to the child.
An adult beneficiary who is incapacitated in some way.
If the beneficiary of a will is not able to manage his or her own affairs and there is no provision in the will for a trust or guardian, the Guardian’s Fund will administer the inheritance.
An adult beneficiary whose lifestyle is risky.
If the beneficiary is unable to manage his or her affairs because of a profligate lifestyle (for example, addiction to drugs or gambling, or a record of criminal associations or reckless spending), a trust will protect inherited assets and give the trustees the right and duty to provide the benefits at their own discretion in the best interests of the beneficiary.
However, Jacobs warns against testators trying to control lifestyles of which they don’t approve.
“What seems to be reckless spending, for example, might just be a different spending style. It’s a question of degree. But even if the person really is a prodigal, at what stage do you stop protecting an adult?”
Hollings points out that attempts by testators to “rule from the grave” can expose trustees to a lot of pressure from beneficiaries, particularly if they are not professional people and are known to the beneficiary.
“Family members or friends may be vulnerable to being manipulated or bullied into releasing funds. A trustee who is a professional accountant or lawyer, and who is experienced and detached, can be very useful as someone the family can hide behind when a beneficiary is difficult,” she says.
A trust creates a separate entity with control over the assets, so it is invaluable as a means of preventing the assets from becoming the target of creditors or falling into the wrong hands – for example, if the surviving partner is exploited, dies intestate, or becomes incapable of managing his or her own affairs.
“It is also very useful in reconstituted families,” Jacobs says. “For example, take a male testator who had a late second marriage, is much wealthier than his spouse and is confronted by the competing interests of his children and her children. He wants to take care of his wife and her children, but once she dies, he would like the remaining assets to go to his children. In that situation a trust can really work: the trustees will see that his wife’s interests are looked after until the final stage of the trust plays out and the assets are transferred to the testator’s children.”
Another reason for placing property in a testamentary trust is to keep it in the family, Murphy says.
“If you have a holiday house and you leave it to the kids, there is always the fear that one of them will persuade the others to sell. In a trust, it can be preserved for generations to come.
“The only problem is that you have to leave sufficient liquidity to look after it (rates and taxes, insurance and maintenance), at least for the first few years. Otherwise, that’s the simplest way for a beneficiary to attempt to pierce the armour of the trust: they can say, ‘we can’t pay the maintenance costs, the rates, the insurance … there’s no money in the trust, so it has to be sold before we are forced into a sale in execution by the municipality’.”
Murphy says testators usually have good reason to want to control the distribution of assets, and it is the job of fiduciary practitioners and planners to listen to their concerns and find solutions via wills and trusts.
“The overriding reason for setting up a testamentary trust is protection of some kind, before tax benefits, and if it is done on that basis, with the right clauses, you may have a will of many pages setting out everything you want to happen.
“For example, you can say: ‘I want my son to go to UCT, but if, by the age of 30, he doesn’t have a degree, then such-and-such should happen’. You can’t say ‘my daughter can inherit only if she marries royalty and speaks Lithuanian by the age of 25’ – that would be ultra vires, or beyond the legal power of the testator – but you can be quite prescriptive. You certainly don’t want to rule from the grave, but I know that if I had inherited a lot of money at age 18, I’d have been off on the next plane and had nothing left by 22,” Murphy says.
The risk of being prescriptive, however, is that life is unpredictable, whereas testamentary trusts are fixed at the time of death. So you can express your wishes, but it is essential to give the trustees wide-ranging powers to deal with the unexpected.
“You can put in clauses that provide flexibility,” Murphy says, “but changing the terms means a costly application to court, which may not succeed. If something is looming that will have a major effect on the trust, such as a change in law or tax policy, or a change in the circumstances of a beneficiary, you’re stuck. With an inter vivos trust, you can adapt it to changing circumstances, change the trustees or even dissolve the trust. So you have to imagine what might happen. I have to ask some really tricky questions to prompt clients to think ‘what would happen if …?’”
The tax implications
A testamentary trust or an inter vivos trust set up for minors or for adults who are incapable of managing their own affairs is regarded as a special trust and is taxed at less punitive tax rates than those that apply to an ordinary inter vivos trust.
A trust is regarded as a special trust if the youngest beneficiary of the trust (person who receives benefits) is still under the age of 21 on the last day of the tax year; or the beneficiary suffers from a serious physical disability or mental illness, as defined in the Mental Health Act, that prevents him or her from earning sufficient income for his or her maintenance or from managing his or her own financial affairs.
If you set up a testamentary trust for minor children, and you want the assets in the trust to be passed on to them only after the age of 21 (for example, at the age of 25), the trust can continue after the youngest child turns 21, but from then until the trust is terminated it will be taxed as a normal trust.
Tax on income earned by a special trust is levied at the same rate that would apply to an individual – that is, the marginal tax rate that is applicable to income at that level. Similarly, a special trust, like an individual, pays capital gains tax (CGT) at a maximum effective rate of 13.3 percent of the gain (where the trust’s marginal tax rate is 40 percent). A special trust enjoys the annual CGT exemption (currently R30 000 a year) and the R2-million exemption for gains made on a primary residence. These concessions are also allowed for two years after the beneficiary of a special trust dies, while the assets are disposed of.
A special trust does not pay transfer duty on the first R600 000 of the value of a property. On the value between R600 000 and R1 million, transfer duty is levied at three percent and between R1 million and R1.5 million at five percent. Only that part of the value of a property that exceeds R1.5 million attracts transfer duty at eight percent.
A normal trust pays income tax at a flat rate of 40 percent and CGT at an effective rate of 26.66 percent of the gain. It does not enjoy the annual CGT exemption an individual enjoys, or the R2-million CGT exemption on a primary residence. It pays transfer duty at a flat rate of eight percent on any property that is transferred to the trust, regardless of the property’s value.
If you need to leave assets to minor beneficiaries or beneficiaries who have physical or mental disabilities, you don’t need to worry about trust tax rates, because the rates are essentially the same as they are for an individual.
If you need to set up a trust for reasons other than providing for beneficiaries who cannot manage their own finances, you will probably find an inter vivos trust better suited to your needs. You must then consider the reasons you need a trust – for example, to keep the growth of your estate in a trust and reduce your estate duty liability or to protect your assets from exposure to your business risks. Then you need to assess the benefits of the trust to you relative to the tax disadvantages.
Remember that an estate needs to be quite large before you need to set up a trust to minimise estate duty.
After permitted deductions (the deceased’s liabilities, bequests to public benefit organisations, property accruing to a surviving spouse and estate administration costs) individuals enjoy an abatement of R3.5 million before estate duty tax is charged at 20 percent. The abatement was only R1.5 million as recently as 2005.
In 2010, the concept of the “portable” estate duty rebate for couples was introduced, which means that any portion of the R3.5-million abatement not used by the spouse or partner who dies first may be transferred to the surviving spouse or partner, so that, together, they can leave R7 million in assets without paying estate duty. In this era of long lives, large estates are less and less common.
Appointment of trustees
Trustees are named in the will and have usually agreed in principle to be trustees well before the will is executed and the trust comes into being. When that time comes, the appointment is not automatic. The executor of the estate approaches the nominated trustees, and at that point they can accept or reject the role. The very first thing to do, Murphy says, is to read the trust deed, or will.
Jacobs agrees that accepting the role of trustee must be an informed decision, based on the contents of the will and a thorough understanding of what the role entails.
“You must have a clear idea of the depth and breadth of your responsibilities, how much time you’ll have to give to the task and whether you have the aptitude. If you are a layperson, you might want to make sure there is a professional person among your co-trustees,” he says.
The will might or might not stipulate how the trustees should be remunerated for their pains, but if there is no such stipulation, “reasonable” fees can be set by the Master of the High Court.
Jacobs says that, typically, fees are charged as a percentage of the annual income generated by the trust, or a smaller percentage of the value of the capital in the trust, or both.
“If the capital consists of, say, a share portfolio worth R1 million, the fee might be 0.25 percent. It depends whether or not it is labour intensive to look after the capital.”
Fees charged in this way, particularly if the capital sum is large, may be disproportionate to the work involved in running the trust.
Angelique Visser, the chairperson of Fisa, says you can negotiate professional trustee fees with the trust company or law firm that you want to use. These could be updated annually in your will, but the work involved and the fee required need to be assessed with each update.
Fees are another important consideration when it comes to the number of trustees you appoint, Jacobs says. “Too many fees might dilute the value of the trust. On the other hand, if remuneration is set by the will and must be divided among the trustees, it will dilute their fees. They might divide up the work, so one [trustee] is responsible for liaising with the family, another draws up the annual accounts, and another looks after the investments, but in the end they are all entitled to a fee. And, of course, a professional trustee – your accountant or lawyer – will not do the job for nothing.”
He points out another danger: “You save money by appointing a relative, make no provision for remuneration, and the relative feels bad asking for any. Then the general principle that you get what you pay for in life applies, and he or she starts to neglect the trust. Although, technically at least, trustees can’t renege on their responsibilities because they’re not being paid, or not being paid adequately. So, once they have accepted the role, you have them over a barrel.”
Powers of trustees
The scope of trustees’ powers is set by the trust deed – in the case of testamentary trusts, the will. The Estate Planning and Fiduciary Services Guide 2013, published by LexisNexis (authors: R King, B Victor, L van Vuren and L Rossini) sums up the general principles as follows.
“The powers that are given to the trustees are usually wide and differ from one trust deed to another. It is important to provide for wide discretionary powers, since the inference may validly be made that the founder intended not to include a power that was not included.
“A trustee may delegate his powers, provided that he does not thereby free himself from liability for the conduct of the person appointed by him or the general body of trustees, and that he could at any time freely revoke the appointment. The trustee chosen by virtue of some special quality may not delegate powers, authority and duties to anyone else.
“A trustee may not abdicate his power to another person and remains in office until he has been removed by the Master, and such other person does not obtain any powers before he has been authorised as such by the Master.”
If the responsibility sounds onerous, it very often is, Jacobs says. “You can’t say: ‘I left that task to so-and-so and I trusted him …’, or opt out when you think you’ve had enough. You must realise that it’s a very responsible position that can last a long time. Sometimes things go wrong, but the responsibility remains with you.
“For example, you come to me to set up a trust for your son, who is a tik addict. That’s a classic example of why you’d create a testamentary trust: he’s irresponsible, at risk. But now the trustees have to face this guy and his irrational behaviour and threats. If it gets too much, you can’t say to somebody: ‘I’ve got a nice job; do you want to take it over from me?’”
Even under more benign circumstances, protecting the interests of a number of beneficiaries of different ages and personalities can call for the wisdom of Solomon, Murphy says.
He cites the example of a young beneficiary who wants the trust to buy him an expensive Italian sports car. He believes that would be to his benefit, but there is no doubt that it would be disadvantageous to the other beneficiaries by reducing the capital in the trust, and thus the income earned.
“So the trustees can say: ‘We can’t buy you an expensive sports car, but we can buy you a compact runabout, because one of the conditions of the trust is that you be supplied with a vehicle.’ It doesn’t say what kind of vehicle, and it doesn’t say it has to be an expensive vehicle. Sonny may be very upset about it, but that’s just the way it is. You get to understand why people set up trusts the way they do.”
Duties and obligations of trustees
Trustees need to look to two sources for the full scope of their duties and obligations: statute (the Trust Property Control Act) and common law.
- To act with care, diligence and skill.
- To perform all the duties imposed by the trust instrument (deed).
- To bank monies in a dedicated trust account and ensure that any account or investment is identifiable as belonging to the trust.
- To lodge the trust instrument with the Master of the High Court.
- To furnish their addresses to the Master and keep them up to date.
- To obtain written authorisation from the Master and lodge security if required in the form of a signed document undertaking to compensate the trust for any loss due to negligence or maladministration. In most cases, the trust deed exempts trustees from the obligation to furnish security (J344 “Undertaking and bond of security” form), but the Master may override that, if it is considered necessary.
- To register trust property, and to ensure that it is always identifiable as trust property.
- To protect the trust’s documents and make sure nothing is destroyed within five years of the termination of the trust.
- To take only reasonable remuneration. The trust deed usually leaves the level of remuneration to the trustees’ discretion, but in the event of a dispute, the Master may decide what remuneration is appropriate.
- To account to the Master when requested to do so. If the accounting is unsatisfactory, the Master may authorise an independent investigation into the administration of the trust.
The common law duties of trustees are:
- To act jointly and find unanimity in making decisions.
- To act independently and in good faith.
- To be impartial and treat all beneficiaries equally (unless the trust deed gives discretion to treat them differently). Impartiality also extends to any conflict of interest, if, for example, the trustee is also a beneficiary of the trust, or would benefit in any way from decisions by the trustees.
- To exercise active management, including investing the trust’s assets productively, because passive management could be construed as negligence.
- To avoid risk and preserve the trust property as far as possible. While keeping assets intact is the first principle, trustees may sell assets if this is necessary to provide necessary income.
- To account to beneficiaries and co-trustees.
- To act within given powers and not to exceed them.
- To make proper distributions to beneficiaries and to distinguish between income and capital.
- To appoint the stipulated number of trustees.
- To ensure that proper controls are in place.
- To obtain expert advice when necessary.
- To comply with all laws.
Rights of beneficiaries
Beneficiaries may be income beneficiaries and/or capital beneficiaries, and they may have vested rights or discretionary rights, depending on how the trust is set up. Vested rights are immediate and clearly defined, with no need for the trustees to exercise their discretion. For example, the trust might stipulate that a teenage child should receive a set monthly allowance until he or she is 25, and then the balance of the income and all the capital in the trust in stages by the age of 30.
A trust that transfers the ownership of property to the beneficiaries, with only the control of the assets residing with the trustees until a given time or event, is known as a “bewind trust”.
Discretionary rights are in the discretion of the trustees, and a beneficiary has no definite or defined entitlement. Where this is the case, the trustees are the actual owners of the assets, but only in so far as they are required to look after the assets and distribute them at their discretion; they have no right of enjoyment of the assets. In this kind of trust, known as an “ownership trust”, it is left to the trustees to decide what the beneficiaries should receive and when, acting in accordance with the instructions in the trust deed, or will.
Discretionary powers usually apply to income, with the capital in the trust vesting in one or more beneficiaries, although discretion can also apply to the capital.
Beneficiaries have the right to expect the administration of the trust to be transparent, efficient and well documented, but they have no right to know the reasoning behind every decision, or “the inner workings”, as Jacobs puts it.
“Aggrieved beneficiaries have some recourse to the Master of the High Court, but it is very limited. The court cannot interfere with the trustees’ discretion or second-guess their decisions. It can bring an action against the trustees only if they are clearly failing in their duties. Trustees may make mistakes – such as investment decisions that, in hindsight, turn out to be poor – as long as they can demonstrate that they applied their minds and acted in what they believed was the best interests of the beneficiaries,” he says.
Given how difficult and thankless the job of a trustee can be, few people would take it on knowingly if they were at risk of being constantly second-guessed in their decision-making by beneficiaries or the court.
The only cost of setting up a testamentary trust is the cost of drawing up the will, which may be done years before the will is acted upon and the trust comes into existence. Because of the time lag, there is a danger of inflation, the stock market or other factors eroding the value of the assets in the trust to the extent that the trust is no longer commercially viable when it is needed. “That is a perennial problem with will trusts,” Jacobs says.
“It is essential to make sure a trust will be viable, not just when it comes into being, but for the expected lifetime of the trust. Of course, it can be reviewed and amended until the death of the testator, but not after that. Also, if you created the trust 20 years ago for your minor children and they’re not minor any longer, the trust will, effectively, never come into existence,” he says.
“Review, review, review … your will and your trust,” Hollings urges.
“Between the signing of a will and the time when it is needed, laws can change, and one benefit that falls away can make a trust unviable. Then you can revise your will and cancel the trust if necessary.
“For example, the introduction of CGT in 2001 – which affects estates, with certain deferments and abatements – changed everything. Yet there are certainly still people who have wills that were drawn up before 2001 and take no account of one of the two major taxes on estates,” Hollings says.
Testamentary trust: A trust set up in terms of a will. The will serves as the trust deed and names the trustees in a unilateral act.
Inter vivos trust: A trust set up during the lifetime of the founder as a contract of sorts with the trustees. The founder hands over assets to the trustees and they accept them, making this a bilateral act.
Special trust: A trust with a special purpose, which qualifies it for a lower rate of taxation. There are two kinds:
- Type A, which is set up in the lifetime of the donor for the benefit of a person, child or adult, who cannot look after his or her own financial affairs; or
- Type B, which is a testamentary trust that benefits relatives of the deceased exclusively, including minor children.
Both kinds of special trust are taxed at the rate applicable to individuals (between 18 and 40 percent), instead of the rate applicable to trusts (40 percent).