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In last week’s article, we unpacked the basics of a Trust by looking at the various role players and some basic tax considerations we need to understand when discussing a trust. In this week’s article, we will unpack the advantages and disadvantages of using a trust to help us better understand why it is a structure that is at all used or considered when managing personal financial situations.
People may want to start a trust for various reasons, as trusts offer several advantages and benefits that cater to different financial and personal objectives. Trusts provide a versatile and customisable legal structure that can address various financial, family, and charitable objectives. However, setting up a trust should be done with careful consideration and the guidance of legal and financial professionals to ensure that it aligns with the individual’s specific goals and circumstances.
Advantages of Trusts
- Asset Protection: One of the primary advantages of a trust is asset protection. Assets placed in a trust are legally separated from the individual’s personal assets, reducing the risk of creditors or legal claims against the individual affecting the trust’s assets.
- Estate Planning: Trusts are effective tools for estate planning. They allow for the orderly transfer of assets to beneficiaries, minimising potential disputes and providing for family members, especially minor children, or vulnerable beneficiaries.
- Tax Planning: Trusts can be used for tax planning purposes, allowing for income splitting among beneficiaries and potentially reducing overall tax liabilities.
- Continuity of Wealth: A trust can ensure that family wealth is preserved and managed effectively over generations, providing a long-term financial legacy.
- Charitable Giving: Trusts can be established for charitable purposes, enabling individuals to support causes they are passionate about and leave a lasting impact on society.
Disadvantages of Trusts
- Cost: Setting up and administering a trust can involve significant costs, including legal fees, trustee fees, and ongoing administrative expenses.
- Tax Implications: Trusts are subject to specific tax rules, and the tax implications can be complex. The tax rates for trusts are often higher than those for individuals, making proper tax planning essential.
- Loss of Control: When assets are transferred to a trust, the individual loses direct control over those assets. Trustees assume management authority and the founder’s ability to access or manage assets may be restricted.
- Reporting and Compliance: Trustees have fiduciary duties and legal obligations, including proper record-keeping and submitting annual tax returns. Failure to comply with these requirements can lead to penalties.
- Duration of Trust: Some trusts have fixed termination dates, which may not align with beneficiaries’ needs or financial circumstances.
- Irrevocability: Once assets are transferred to an irrevocable trust, it is challenging to change the terms or reclaim the assets, limiting flexibility.
Be aware, and take the necessary steps, to avoid the risk of having a court rule, or SARS find, your trust to be considered an “alter-ego” trust, or as it is also commonly referred to, a “sham” trust. This can be the case when the founder of a trust still maintains total control of the assets within the trust and as such the trust is considered an extension of the founder.
In such a case, the trust is meeting all the necessary requirements to be considered a trust yet if it can be shown that the founder or trustees are not acting with the required care and diligence in terms of the Trust Property Control Act as they are not acting independently.
Such sham trusts are often found in cases where the founder wants to defraud a party such as their spouse or a creditor or when they are trying to avoid tax liabilities. Ensure that at least one of the trustees of your trusts is a professional and independent trustee and that proper procedures are followed and recorded to show that there is a clear separation of ownership and control between the trust and the founder.
Overall, trusts can be a beneficial tool when managing your personal finances. However, setting up a trust should be done with careful consideration and the guidance of legal and financial professionals to ensure that it aligns with the individual’s specific goals and circumstances. In next week’s article, we will conclude our discussion on trusts by looking at the different trust structures in South Africa.