Build generational wealth in South Africa

Browsing the internet for transferring generational wealth, you’ll find answers that will make you involuntarily bleed out of your anus but are important nonetheless. You obviously need to follow the following online advice to build and successfully transfer generational wealth:

1. Create a post-matric fund for your child
2. Invest in the stock market and buy property
3. Start a family business
4. Teach your loved ones about financial management
5. Transferring your wealth successfully

I am assuming you’ve already started with the above and want the right structures in place.

But now, let’s talk about generational wealth for a second. Ideally, you want to transfer your wealth (belongings, money and property) successfully to the next generation. And this should be done by paying minimum taxes, without severe time delays when you die and with maximum long-term sustainability.

To transfer your wealth successfully, consider leveraging trusts as an excellent vehicle. Trusts, as separate legal entities, enable you to create a distinction between yourself and your assets, safeguarding them from inclusion in your estate upon your untimely death. For this article, let’s chat about different types of trusts, their tax impact and how to use them to your advantage. 

Trusts in South Africa – what is it?

A trust is a legal entity that allows individuals to separate ownership and control of assets from themselves. This means that a trust cannot be an extension of yourself or your family – it’s a separate legal entity. You will therefore need at least one external trustee to avoid it becoming a family affair. But wait – what’s a trustee? Let’s discuss in short all the role players of a trust. 

There are three main parties: the settlor, who establishes the trust and transfers assets into it; the trustees, who manage the trust assets according to the trust deed’s terms; and the beneficiaries, who benefit from the trust’s assets. 

But did you know there are different types of trusts? As per the government website (where all truth is revealed):

A trust is a legal arrangement whereby control over property is transferred to a person or organisation (the trustee) for the benefit of someone else (the beneficiary). You can register two types of trusts, namely the inter-vivos trust and the testamentary trust. 

South African Government Official Information

The different types of trusts

On the other hand, a testamentary trust is created through a clause in the founder’s will, becoming effective only after their death. While an inter vivos trust is costly during the founder’s lifetime, a testamentary trust incurs dying costs and taxes. To illustrate this, let’s look into the fees payable for getting a property into a testamentary trust:

• Legal Fees: Engaging a legal professional to draft or amend the founder’s will to include the testamentary trust clause and facilitate the transfer of property to the trust may incur legal fees.
• Transfer Duties, bond and transfer costs: SARS and the governments would like a cut of the money, and therefore, fees will be payable.
• Administrative Costs: This can include fees for document processing, notarization, and registration with the Master of the High Court.
• Valuation Fees: You can’t just claim a property is worth R 1. Therefore, you probably would need to get the property valued, which costs money. 

If the beneficiaries want to make changes to a testamentary trust, they need to amend the will, which could potentially lead to complexity, more legal fees and delays in asset distributions.

With the complexity of the law being what it is in South Africa, it is recommended to get some serious legal advice if you want to set up a trust. For example, assets transferred to a testamentary trust for the benefit of a surviving spouse may qualify for a deduction from estate duty. Additionally, assets left to a surviving spouse in a bequest may be exempt from estate duty altogether.

Why should I use trusts for generational wealth? 

There are a few reasons why trusts are highly recommended for generational wealth:

• Tax: When you have assets in your name, you are taxed in your personal capacity at your normal tax rate. This can be extremely taxing – but trusts with the right tax planning can reduce the tax burden.
• Limited Liability: If legal action is taken against you (or you’re declared bankrupt), trusts can protect your assets against creditors.
• Diversifying control: You, with other trustees, can decide how and when to pay out money from your estate/belongings to beneficiaries

Let’s unpack.

How does death affect the assets I leave behind?

Dying is expensive. Very expensive. Let’s take the example of a natural person, who died. The estate needs to pay:

• Executors fees (3.5% of GROSS if it’s your bank)
• Estate Duty (20% on the portion of the estate above R3.5 million)
• Transfer duties, property valuation fees, lawyer fees

So assuming you have a R5mil GROSS estate, fees are R420 750 including VAT, but excluding all property-related fees such as bond, transfer costs and transfer duties. So roughly, we’re looking at a 10% fee.

As trusts never die, there will be no need to pay estate duties or executor fees. You will however need to pay transfer duties getting your property into the trust.

Trusts are great for saving on taxes

Most people who create trusts are in the > 28% tax brackets. Even though trusts are taxed at 45%, you can pay money to beneficiaries, who are allowed to ‘benefit’ from the profits/proceeds of the trust. Let’s take two scenarios to explain how trusts and tax work:

• A trust is receiving rent from an investment property. The trustees (and trust deed) authorised the rental income to be paid out to two beneficiaries, who in their personal capacity, is in the 26% tax bracket. There is a tax saving of 19%.
• A trust sells a property and makes R 500 000 in profit. Trusts pay 36% in capital gains tax (CGT). Therefore:
  • 36% of R 500,000 = R 180,000.
• The proceeds are distributed to two beneficiaries, who in their personal capacity, are in the 26% tax bracket. They have a CGT exclusion of R 40 000, where the 40% of the remaining proceeds is taxable at their normal tax rate. therefore:
  • Taxable amount = 40% of R210,000 = R 84 000
  • At a tax rate of 26%, the tax payable for each beneficiary would be:
  • Tax payable = 26% of R 84 000 = R 21 840 per beneficiary

That’s a serious saving! However, if you are the only beneficiary, this might not be as tax efficient.

You can still claim tax breaks on property in trusts

Certain tax breaks such as Section 13 sex could also be applied to a trust. For this, you need to have 5 or more new or unused properties (ie the trust is the developer or the trust bought it directly from the developer) and claim up to 10% pa back over 20 years.

Can I put my primary residence in a trust?

Absolutely. Trusts aren’t just for money-generating assets such as property, IP or stock portfolios. Many high-risk people (e.g. politicians and dodgy underground people) already have most of their assets in a trust, company or both.

When transferring assets into a trust, there will be taxes payable – but could pay off in the long run. 

How do I transfer my assets into a trust?

Unfortunately, as a separate legal entity, you can’t gift the trust with your life savings. You can sell it to the trust or gift R 100 000 per year through a donation, without the need to pay donations tax. In the case of investment properties, you would need to transfer the property into the trust, triggering taxable events that will make you bleed. 

What fees are payable for transferring my property into a trust?

When adding your property into a trust, you will be liable for paying:

You, as the seller will be liable for

• Certificates of compliance
• Estate agent commissions (if any)
• Capital Gains Tax (CGT)

Remember – you can’t sell your property for R1. You, as the seller, could also be taxed by capital gains tax (CGT) if this is not your primary residence or if your proceeds are more than the non-taxable amount.

What other taxes should I consider with my trust?

• Trust income tax: Trusts are taxed at a flat rate of 45% on income they generate, with some exceptions for specific trust types.
• Donations tax: Applicable when donating assets to trusts exceeding the annual exemption limit.
• Dividends tax: Taxed when companies distribute profits to shareholders, including trusts, dividends tax will be payable
• Capital gains: 80% of all capital gains are taxable at the normal tax rate of the trust (which is 45%).

Please note that you’re still able to distribute the proceeds to beneficiaries that would change this horrific tax situation in one where your unicorns poop rainbows.

Comparison between trusts and a person dying

Dying in South Africa is expensive. There are so many taxes to pay, such as executor fees, estate duty and property duties such as bond and transfer costs, transfer duties, sectional title certificates of good standing, etc. Let’s take the example of a natural person, who died. The estate needs to pay:

• Executors fees (3.5% of GROSS if it’s your bank)
• Estate Duty (20% on the portion of the estate above R3.5 million)
• Transfer duties, property valuation fees, lawyer fees

So assuming you have a R5mil GROSS estate, fees are R420,750 (incl VAT), excl. all property-related fees such as bond, transfer costs and transfer duties. Death, taxes and Cher are unavoidable. But a trust can assist in making the tax burden a lot less – especially on the property frontier. 

As trusts never die, your money will be safe when you pass away. They will probably elect another trustee in your place!

What does a trust cost?

When setting up a trust, you will need to pay a lawyer for their time to set up the contract and submit it to the relevant bodies. Setting up a trust costs roughly between R 6 000 to R 12 000.

There will also be running costs involved for the trust, such as tax and accounting fees, as well as for the external trustee. I’ve seen attorneys charging anything between R 10 000 – R 20 000 per annum for being an external trustee!

How to create a trust

Trusts are governed by trust law (The Trust Property Control Act, 1988). It is a legal requirement to draft a valid trust deed that aligns with this legislation. This deed, guided by a qualified professional, outlines the settlor, trustees, beneficiaries, trust property, distribution rules, and provisions for dispute resolution.

Once the trust deed, crafted by a legal expert, is signed and witnessed according to legal standards, its validity is ensured. Additionally, the trust deed might require notarization or certification by a commissioner of oaths. Following the creation of the trust deed, it will be presented to the Master of the High Court for approval and registration. After registration, the trustees must open a bank account in the name of the trust to manage its finances. Remember – a trust is a legal entity on its own!

It’s essential to appoint trustees who are capable and trustworthy individuals or entities to manage the trust assets and fulfill their fiduciary duties. 

Finally, ongoing compliance with trust law and reporting requirements is necessary to ensure the trust operates legally and effectively. this would include accounting and tax submissions.

Conclusion

In conclusion, trusts in South Africa offer affluent investors a robust strategy for building generational wealth by providing a shield against potential creditors, enabling efficient asset/property distribution among beneficiaries, and offering tax optimisation opportunities.

The two types of trusts – inter vivos and testamentary trusts are amazing tools to transfer your wealth to future generations. Legal fees and transfer duties, and other fees might be payable early on to get your assets in a trust, but the long-term benefits of tax efficiency and asset protection outweigh these expenses in many cases.  Yes, you are going to need legal assistance with this – but please do your research and don’t sign anything you don’t understand.

Happy investing!