Loading...
Wealth

What is a trust fund and how does it work?

We have all heard of trusts at some point in our lives, trusts are often associated with the ultra-wealthy. However, trusts can be used by just about any middle-class family, they are very important when it comes to estate planning. This is a guide to how trusts work in South Africa.

What are trusts?

Investopedia describes a trust as a fiduciary relationship in which one party, known as a trustor, gives another party, the trustee, the right to hold title to property or assets.

A trust is basically a way to move assets out of your personal estate and put them in a vehicle that protects them against a lot of issues in life. Trusts are commonly used as a way to distribute wealth upon the death of a trustor.

They are a way to avoid going to the courts as beneficiaries of the trust are listed and will get everything. Your family members can go to courts and fight over your wealth when you die, this means that all your finances will be a matter of public record. Your creditors will also contest for the money that you owed them. This ends up being a messy battle and the courts will divide your wealth however they see fit.

The best way to avoid this is by using a trust, a trust has clearly defined beneficiaries and your wealth only goes to those beneficiaries. Trusts are also a good way to avoid paying taxes on your estate. Trusts can be divided into two main categories; living trusts and testamentary trusts.

Living trusts

Also known as Inter-Vivos trusts, are created during the lifetime of a person. People set up living trusts for a number of reasons, there are a lot of different subcategories under this category. You are able to benefit from a living trust while you are still alive.

People use living trusts as a way to protect their assets from their creditors or from their spouse in the case of divorce. All assets that you put in a trust are no longer counted as your personal asset and therefore no longer form any part of your estate. Your assets will be protected should you be sued or face any legal battles.

You can put just about any asset in a trust, your house, cars, shares, business stocks and other assets. Some people use trusts as a way to reduce their tax burden. If you buy an asset for R500 000 and put it in a trust, let’s say this asset grows in value and is worth R1.8 million by the time you die.

Your beneficiary will not need to pay tax on this increase. The cost value of this asset will be counted as R1.8 million, if your beneficiary sells the asset for R1.9 million; then only R100 000 will be taxable.

Testamentary trusts

A testamentary trust is a trust that is created after you have passed on. It comes directly from the will, where the deceased appoints a trustee to manage the assets of the deceased.

All assets of the deceased will be passed to the trust and will be distributed to the beneficiaries. A trustee is appointed to manage the trust until a set time, when the trust expires. This might be after a certain number of years or when a certain event happens like a beneficiary graduating from university or college. The vast majority of people choose to make living trusts.

Revocable trusts

A revocable trust is a trust that you have access to and can change the details of the trust or cancel it altogether. The income earned from a revocable living trust is distributed to the trustor. This may be income in the form of dividends and profits from business. Only after death does property transfer to the beneficiaries of the trust.

Revocable trusts are very safe but creditors may get their hands on them in some instances. Moving your assets into a trust in anticipation of a lawsuit is considered to be fraudulent and can be reversed by the court.

Irrevocable trusts

These are trusts that are mainly targeted at the ultra-wealthy. You cannot change the details of this trust, whatever is signed on the date of opening the trust is final. Assets are moved completely out of your estate; they are protected from all your legal issues.

Even the grantor (trustor) cannot withdraw any assets that have been contributed to the trust or withdraw them. Assets that are part of the irrevocable trust don’t form part of your taxable estate. A living trust becomes irrevocable at the death of the grantor. Testamentary trusts are irrevocable by default and can’t be changed.

Types of trust funds

People open trust funds for different reasons, there many times of trust funds that you can open. You can open a trust fund for just about anything. Here are some of the most commonly used ones.

Asset Protection Trust

They mainly for protecting your assets against future creditors. Not your current creditors. You can’t use your assets as leverage when asking applying for a loan then proceed to put them in a trust. That is fraudulent, however, future creditors will not be able to get your assets if they are in this type of trust.

Special Needs Trust

You may have a child who is benefitting from government programmes due to their special needs. The government may disqualify your beneficiary if they suddenly receive a huge lump some of money and assets. A special needs trust is designed to prevent just that.

Generation Skipping Trust

This is a trust that you setup if your beneficiaries to be your grandchildren. The money can be used to fund their education and lifestyles. GSTs usually have tax benefits.

Complexities

You don’t need to have only one trust; you can set up multiple trusts for different purposes. The only requirement is that you fund them, funding a trust just means putting assets into the trust.

You can detail exactly how you want your estate to be distributed, this is something you don’t have control over with a will. You can release a certain amount of your estate when your beneficiaries cross certain milestones in life. A trust may help you fund your children’s education and you have the option to release the estate in small portions.

You may want to assist your grand children with buying a house, you have the option to direct the trust to assist them with contributing 50% of the price of whatever house they choose. Estate can also be released at different times and when your beneficiaries reach a certain age.

Conclusion

Not having a trust or will often results in battles over your estate. These battles have to be settled by courts. A will can be contested and usually has to go through probate. A trust is a perfect tool to manage your estate. Do you have any thoughts or questions? Comment below.

One comment
Leave a Reply

Your email address will not be published.