Which type of trust to choose: testamentary or living?

The effects of establishing a living or a testamentary trust differ completely, writes Phia van der Spuy. This is another article in a series on trusts for Personal Finance and its sister publication, Business Report.

WHEN people seek estate planning advice, they may be advised to consider a trust.

However, people are advised to avoid the hassle of establishing a trust while they are alive (a living, or inter vivos, trust) and instead have a trust registered upon their death (a testamentary trust).

Although advisers may tell their clients that, in either case, the effect will be similar, the effect of the two types of trust is vastly different, and you need to understand this difference before making a decision.

A trust may be used to hold and protect personal or business assets. This is particularly beneficial in the event of subsequent liquidation, sequestration or divorce.

Trusts may also be used to hold shares in businesses to ensure continuity in the ownership of assets.

Setting up a special trust for a mentally disabled or incapacitated person allows for the safe custody of assets, and has the benefit of lenient income tax and capital gains tax (CGT) treatment.

Trusts can also be used to avoid the need to place a person under curatorship. This is particularly true for people who suffer from Alzheimer’s disease or senile dementia. If you have created a trust during your lifetime and become afflicted by one of these conditions, your financial affairs would continue as before, with persons whom you entrusted as the trustees of the trust.

On the other hand, you may be a single parent, a salaried employee, who is worried about who will look after your children’s financial affairs when you are no longer around.

Trusts also have an important role to play in estate planning and will affect your decision in terms of how much risk and life assurance you require. This is because setting up a trust will affect how much estate duty and CGT your estate will pay and the provision you make for your dependants after your death.

INTER VIVOS TRUSTS

An inter vivos trust is established during your lifetime in order to manage certain assets or investments, and support beneficiaries, such as family members, during your lifetime and after your death.

The objective of an inter vivos type of trust is usually to protect assets and to provide an income for beneficiaries.

It is also used to transfer assets to the capital beneficiaries (in other words, the beneficiaries who may receive trust assets and profit on the sale of trust assets) during the lifetime and on the termination of the trust.

Inter vivos trusts are ideal for keeping growth assets (shares, properties and alternative investments) out of your estate and are a superb mechanism for limiting estate duty and protecting assets from generation to generation.

These trusts can be structured as either vested or discretionary inter vivos trusts.

In a discretionary trust, the trustees have the right to decide how much income (or capital) to award to each beneficiary, whereas in a vested trust the beneficiaries are the rightful owners of the assets and therefore have a right to them, but the administration is taken care of by trustees until, for example, a child turns 25. On the death of the beneficiary, these assets will be included in his or her estate. The beneficiaries will be liable for all taxes resulting from the assets.

Complications can arise in vested trusts in the event of a beneficiary’s insolvency or death.

A discretionary trust is extremely flexible and can be used to take into account any family, financial and legislative circumstances. This means that the trustees can manage the trust’s assets in the best interests of the beneficiaries by taking into account all the relevant factors at that time. This flexibility caters for uncertainties such as divorce, insolvency, an increase in family size, a change in the family’s fortunes, and changes to tax legislation, provided the beneficiaries are defined and the trust deed is drafted in such a way to anticipate these uncertainties.

TESTAMENTARY TRUSTS

Testamentary trusts come into existence after the death of the founder. They are commonly known as “will trusts” and, as such, are created in terms of the will of a deceased person.

The implication is that during your life your assets will not be protected, and on your death taxes will be paid first on the value of the estate, before it is transferred into the trust.

Testamentary trusts are particularly suited to the protection of the interests of minors (because minor children cannot, in terms of South African law, inherit anything) and other dependants who are unable to take care of their own affairs on the death of the person supporting them, if such a person is a salaried worker without too many assets.

In the absence of a trust (testamentary or inter vivos), assets from a deceased estate left to minor children are sold, typically placed in the Guardian’s Fund and the money is paid to them when they reach adulthood.

The child’s guardian does not necessarily have to be a trustee; in fact, it is often a good check and balance to have a separate, independent person who is financially astute as a trustee.

Testamentary trusts are created at the winding up of a deceased estate, following a specific stipulation in a person’s will that a trust be set up. Such a stipulation serves the same purpose as a trust deed.

The terms of a testamentary trust are typically not as detailed as those for an inter vivos trust, which often causes problems with its execution. Sometimes, a full trust deed is attached to a will, instead of incorporating the usually shorter provisions of a testamentary trust in the body of the will. This serves to provide additional comfort and assurance that the testator’s wishes will be honoured.

If, for any reason, the will is invalid, the trust will not come into effect. The Master of the High Court has the power to declare this type of trust invalid, unlike an inter vivos trust, where the Master of the High Court has no such power. This may have grave repercussions for your loved ones.

Generally, the terms of a will trust cannot be amended, but the Trust Property Control Act does give the court certain powers to amend this type of trust instrument. This makes a testamentary trust inflexible.

CONCLUSION

Clearly, you need to establish your financial and personal goals and understand your personal financial risk before you decide which type of trust will best suit your needs.

Each type of trust will have vastly different implications, which you need to understand before you are convinced by your adviser.

Phia van der Spuy is a registered Fiduciary Practitioner of

South Africa and the founder of Trusteeze, which specialises in trust administration.