What is a Testamentary Trust?
Simply put, a testamentary trust is a type of trust that is provided for in the will of a testator and is created after his or her death when the deceased estate is wound up. It is also known as a will trust or a trust mortis causa.
Contrarily, an inter-vivos trust, also called a living trust, is created while an individual is still alive.
Trusts are governed by the Trust Property Control Act (Act 57 of 1988) in South Africa.
A Quick Overview of a Testamentary Trust
✔️What is a testamentary trust?
✔️What is a testator?
✔️The creation of a testamentary trust
Some reasons and circumstances for creating a testamentary trust
Trustees of a testamentary trust
Testamentary trusts and taxes
Costs pertaining to a testamentary trust
Finally, a word of caution
What is a Testator?
Testator refers to an individual who makes a will. It is a term that has come to be applied to both sexes.
The creation of a Testamentary Trust
A testamentary trust is created at the winding up of the estate of a deceased person. Its creation is activated by the specific stipulation in a deceased’s last will that a testamentary trust must be set up.
The indications and conditions concerning the creation of a testamentary trust are the same as a trust deed, setting out the framework in which the trust must operate, including its terms, such as its powers and limitations.
The testator serves as the founder of the trust. Put differently, as founder, the maker of the will is the person who forms the trust. The founder, also referred to as the ‘settler’ or ‘donor,’ appoints the trustees of the trust.
Drafting a will is an essential part of estate planning. In addition, keep in mind, certain formalities have to be met in order to create a will trust. Therefore, it is advisable to get a fiduciary practitioner that specialises in estate planning, including drafting wills and creating testamentary trusts, to assist you.
As with all trusts, beneficiaries should be clearly defined, and their rights and entitlements should be explicitly described.
Beneficiaries are, inter alia, the individuals, organisations, institutions, or churches who qualify to benefit from the trust, either by receiving income and or capital or assets from the trust.
Some Reasons and Circumstances for creating a Testamentary Trust
Although an effective method to provide for specific circumstances of heirs after one’s death, a testamentary trust’s aim, preferably, must no be ‘to rule from the grave.’
Try to avoid requirements and stipulations that are too restrictive. Rather, consider flexible measures that are adaptable to circumstances which might be unknown to the testator at the time of his or her death.
Disability
A person may have a strong desire or obligation to provide for a beneficiary, such as a child, who has a physical or mental constraint which engenders the beneficiary unable to manage and take care of his or her own affairs and assets.
The parents may provide for sufficient cash in the trust, enabling the trustees to provide either partially or fully for the person’s needs for the duration of his or her life, or the period of the handicap.
The founder of the trust should indicate who is to inherit the cash available when the beneficiary dies. It is important to keep in mind that a child may be physically capable of becoming a parent, despite his or her mental impediment. Therefore, upon death, it is preferable that the will trust should cease in favour of the beneficiary’s children, or in favour of his or her siblings in the absence of children, or any other beneficiary the testator may nominate.
Heir is a minor
This is one of the main reasons why people provide for testamentary trusts in their wills. A testamentary trust is an appropriate strategy to protect the interests of minors because they are not allowed, according to South African law, to inherit any assets.
A minor does not have the legal capacity to be party to an agreement or contract without the assistance of a legal guardian. Regarding immovable property bequeathed to a minor, the property must be registered in the name of the minor child and managed by the legal guardian until the child reaches age 18.
In the absence of a testamentary trust, all assets bequeathed to a minor child are transferred to the Guardian Fund which is administered by the Master of the High Court. The money, with accrued interest, is paid to the beneficiary when he or she reaches adulthood. Generally, money administered by the Guardian Fund is invested very conservatively which has a negative impact on the value of the inheritance, especially over the long term.
Bear in mind, only money can be transferred to the Guardian Fund.
Typically, the trust terminates when the beneficiaries reach a certain age, for example 23 or 25 years.
It can also be necessary to create will trusts for heirs older than 18 years, who lack the necessary responsibility and experience to take care of a substantial inheritance.
Heir is a spendthrift
Unfortunately, there are instances that heirs need to be protected from themselves, such as when an heir is a spendthrift, ‘spending money like a drunken sailor.’
In such a case, the entire inheritance, with the possible exclusion of a vehicle, furniture, and household goods, may be left in a trust. The child may have permanent use of a place of residence and the trustee could pay him or her a reasonable income on a regular basis.
The testator has to decide who is to receive the inheritance on the death of the child.
With regard to the termination of the trust, the testator has, inter alia, the following options:
- the child’s inheritance remains in a trust until he or she has reached a certain age, regardless the degree of his or her financial responsibility and ability to manage money.
- the heir’s inheritance stays in the trust for his or her lifetime.
Grandchildren or a subsequent generation as ultimate beneficiaries
Grandchildren or a succeeding generation are nominated as the ultimate beneficiaries.
The trust allows generations in between limited access to the trust funds, avoiding unnecessary estate duty. The age of the next generation and their current financial position and means are important factors in the decision to create a will trust as an intervening trust.
Provision for an heir’s education
Typically, this type of trust can be utilized by parents, grandparents, or a wealthy family member.
Usually, the purpose is that the money is to be used for studies after grade 12 (matric). However, with the rising school fees, especially private school fees, the inheritance money could also be used for education before leaving school.
Therefore, it is sensible to avoid defining the purpose of the inheritance in a strict sense, such as ‘post-school studies’, or even ‘post-matric studies.’ Instead, a description such as ‘educational expenses’ is a much more flexible description, allowing for different education opportunities.
Asset protection
A testamentary trust is a wise strategy to protect your assets or property after your death. Property or assets which should be moved into the trust must be specified.
Moving your assets to a trust, offers added protection to your heirs’ inheritance should they, or one of them, come under attack from creditors, such as in a bankruptcy situation.
A testamentary trust can own immovable property, receive donations, and inherit money from the founder’s estate. When correctly managed by competent trustees, the founder’s assets are protected.
Examples where asset protection is necessary, are:
- an asset is not divisible, such as a home, holiday home, or agricultural land (farm); and
- to prevent a spouse from losing control over assets on remarriage.
Trustees of a Testamentary Trust
The founder of a testamentary trust appoints the trustees of the trust in his or her last valid will.
There is no limit to the number of trustees that a trustor can appoint. A beneficiary can also be a trustee.
It is good practice to appoint at least two trustees, one of them, preferably an independent person who is financially astute. Nowadays, many people prefer to appoint the fiduciary practitioner, who has drafted the will and trust, as trustee beside a family member or a trusted friend.
A child’s guardian does not necessarily have to be a trustee.
Provisions in the Trust Property Control Act (Act 57 of 1988, Section 6) determine that any person appointed as trustee may only act as one after obtaining written authorisation by the Master of the High Court. Nominated trustees must apply for Letters of Authority from the Master of the High Court and are only allowed to proceed after the date of authorisation on the Letters of Authority.
If for any reason, a chosen trustee declines to act as a trustee, someone else may volunteer and obtain the necessary authorisation. Otherwise, the court will appoint a trustee.
A trustee can be removed in certain circumstances. It can be done according to the procedure set out in the testator’s will. If there is no such a procedure stipulated, a petition can be filed with a court to remove a trustee for, inter alia, the following reasons:
- the trustee violated or attempted to violate the terms of the trust; and
- the trustee becomes insolvent or incapacitated.
It is of crucial importance to stipulate when exactly a trust must terminate, as well as what the duties of the trustees entail upon termination of the trust. Needless to say, the termination of a trust also terminates the responsibilities of the trustees.
The Trust Property Control Act also contains provisions with which all trustees must comply. Non-compliance may lead to criminal sanction.
Trustees are appointed to manage the assets of the deceased. The trustees owe a fiduciary duty to the beneficiaries of the trust and are required to manage and administer the trust solely for the benefit of the beneficiaries, acting objectively and in good faith.
Moreover, trustees have a moral and legal obligation to act honestly and trustworthy, using the following as moral compass:
- Incorruptible – trustees may under no circumstances gain secret profits from trust assets or speculate with trust assets.
- Conscientiousness – trustees must ensure that they act with the necessary expertise, showing due care when making decisions with regard to the trust assets.
- Compliance – trustees are legally bound and compelled to execute the stipulations and requirements of the trust deed.
More examples of the duties and obligations of trustees:
- to perform all the duties as described in the trust deed;
- to deposit monies in a dedicated trust account;
- to ensure that any account or investment is identifiable as belonging to the trust;
- to invest the proceeds of assets and surplus income for the benefit of the trust;
- to call up and reinvest investments as the trustees may deem fit;
- to register trust property, and to make sure it is always identifiable as trust property;
- to provide the trust income for the maintenance, expenses, obligations, and costs of the trust;
- to protect the documents of the trust, ensuring nothing is destroyed within five years of the trust’s termination;
- to take only reasonable remuneration;
- to be impartial, treating all beneficiaries equally, unless the trust deed indicates that they are to be treated differently;
- to be accountable to beneficiaries and co-trustees;
- to make bona fide distributions to beneficiaries;
- to make use of expert advice when necessary; and
- to comply with all laws, such as the Income Tax Act (Act 58 of 1962).
Testamentary Trusts and Taxes
All trusts need to register with the South African Revenue Services (SARS). Normally, a trustee is the representative taxpayer of a trust.
Trusts are taxed at a flat rate of 45% – also the highest rate applicable to individuals. Special trusts are taxed at a sliding scale from 18% to 45%, the same as natural persons. However, a special trust must be set up in terms of the Income Tax Act to qualify for this favourable tax rate.
SARS recognises the following special trusts:
- Special Trust Type A – ‘a trust created solely for the benefit of a person(s) with a “disability”, as defined in section 6B(10, where the disability makes it impossible for the person(s) from earning enough money for their care or from managing their own financial matters.’
- Special Trust Type B – ‘a trust created solely for the benefit of person(s) who is a relative of the person who died and who are alive on the date of death of that deceased person (including those conceived but not yet born), and the youngest of the beneficiaries is younger than 18 years on the last day of the year of assessment.’
Capital Gains Tax (CGT) is the same for special trusts and individuals, 18% since the 2018 tax year.
Costs pertaining to a Testamentary Trust
Costs to create a testamentary trust differ from service provider to service provider and depends, among other things, on the duration of the trust and the value of the assets held by the trust.
There is also a fee payable when a trust is terminated.
Finally, a Word of caution
If the will is invalid for some reason, the testamentary trust will not be valid. The Master of the High Court has the authority to declare a will trust invalid, unlike an inter-vivos trust, where the Master of the High Court has no such power.
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