Estate planning simplified: Protect your family with a testamentary trust.

Estate planning may sound like something only attorneys and the wealthy should be concerned about, but it is actually a way of ensuring that your money, house, and other possessions are distributed to your loved ones upon your death. A will is a major component, as the document stipulates who gets what after you pass away. However, you sometimes need more than a basic testament to provide for your spouse and children while also saving on tax. This article explains how a testamentary trust can assist you with the use of a tax benefit referred to as the Section 4(q) deduction.

What are estate duty and capital gains tax?

Upon your death, the government can take a portion of what you leave behind as tax. This is what you need to know about the two main taxes:

• Estate duty: This is a duty on everything you own upon your death – your house, car, savings, investments, everything. The first R3.5 million of your estate is duty-free, but after that, the duty is 20% if your estate is worth up to R30 million, or 25% if it is worth more. So, if your estate is worth R5 million, the dutiable amount is R1.5 million (R5 million minus R3.5 million), and the duty will be R300 000 (20% of R1.5 million).

• Capital gains tax: This is a tax on the profit your assets made over time. If, for example, you bought a house for R1 million and it is worth R2 million upon your death, that profit of R1 million may be taxed. When you pass away, there is a once-off exemption of R300 000 (which means that the first R300 000 of the profit is not taxed), but anything over this amount is taxed at your personal rate, with 40% of the profit included in your taxable income.

These taxes can reduce what your family inherits, but there is a way to avoid estate duty when you bequeath your assets to your surviving spouse.

What is a testamentary trust?

A trust is like a strongroom for your assets. You put your money or property in it, and someone you trust (called a trustee) manages it for the people you want to benefit (called beneficiaries). A testamentary trust is a trust you create in your testament – it is only activated after you pass away. Think of it as a way of giving instructions on how your belongings should be dealt with when you are gone.

In this case, a testamentary trust can help to look after your spouse while ensuring that your children also inherit something later. It is like saying: “Give my spouse  the income from my assets but preserve the assets themselves for my children.”

The Section 4(q) deduction: a tax-saving possibility

South Africa has a rule known as the Section 4(q) deduction, which states that, if you bequeath your assets to your surviving spouse, no estate duty or capital gains tax is payable upon your death. This usually happens if you leave everything directly to your spouse. But what if you are concerned that your spouse will spend everything, remarry, or not leave anything to your children? This is where the testamentary trust comes into play.

You can set up the trust in such a way that your spouse gets the benefits (such as income) while you still qualify for the tax benefit, and that your children get the assets later. This is a win/win: no tax now, and your children are protected in future.

How does it work in your testament?

This is the basic plan for setting up a testamentary trust with the Section 4(q) deduction:

1. Write your testament: State in your testament that, upon your death, your assets should go into a trust for your spouse and children.

2. Spouse gets income: The trust pays your spouse the income it generates – such as rental from a property or interest on investments – while they are alive.

3. Children get the assets later: The trust preserves the actual assets (the “capital”) in safekeeping. When your spouse passes away (or in the event of something else you stipulate, such as remarriage), the trust is dissolved, and your children inherit the remainder.

4. No tax up front: Since the assets technically go to your spouse via the trust, you avoid estate duty and capital gains tax upon your death.

To make this work, your testament should be quite clear. Your spouse should be the only one who receives an income, and the trustees may not be free to give money or assets to anyone else while your spouse is still alive. If this can happen, you lose the tax benefit.

Here is a simple example of how your testament may read:

"I bequeath all my assets to a trust for my spouse [Name of Spouse]. The trust shall pay all income to my spouse during their lifetime. Upon the death of my spouse, the children shall become the beneficiaries.”

This is just an explanation – your attorney will need to adapt it to the rules.

Who counts as a “spouse”?

The law says that a “spouse” is not just someone to whom you are legally married. It may also include the following:

• A partner in a customary union (as recognised in terms of applicable legislation).

• A partner in a religious union (as in terms of Islamic or Hindu rites).

• A life partner in a permanent relationship (same or opposite sex), as long as it is intended to be permanent.

This means that the tax benefit may apply to more than just traditional marriages, which is terrific for all types of families.

Benefits of this plan

Using a testamentary trust with the Section 4(q) deduction offers significant benefits:

• Saving on duty: No estate duty upon your death, so there is more left for your family.

• Support your spouse: Your spouse gets an income, which provides them security.

• Protect your children: The assets are preserved for your children, even if your spouse should remarry or get into financial difficulty.

What to look out for

There are a few things to consider:

• Tax within the trust: The trust itself must pay tax on the income it generates (at 45%) or capital gains tax (at 36%). But if the income goes directly to your spouse, it is taxed at their rate, which may be lower.

• Use the right wording: If your testament is not clear, or gives the trustees too much freedom, you may not enjoy the tax benefit. This is why you will need assistance from a professional.

An example

Imagine Jack is married to Jill and has two children. Jack’s estate is worth R5 million, including a house which has doubled in value. He wants Jill to be taken care of when he passes away, but also wants the children to inherit something. This is what he should do:

• Jack writes a testament setting up a testamentary trust.

• The trust gives Jill all the income (say, R50 000 per annum from investments).

• Upon Jill’s death, the children become the beneficiaries of the trust.

When Jack passes away, there is no estate duty on the R1.5 million, which would otherwise have been dutiable, saving R300 000. Jill lives on the income, and the children later become the beneficiaries of the entire estate.

Why you need a professional

These things can become complicated. If your testament is not written exactly right, the South African Revenue Service can refuse the tax benefit. An expert who knows the rules can ensure that everything is set up correctly. They will also help you decide when the trust should be dissolved – such as after your spouse passes away or remarries – and how to deal with tax within the trust.

Conclusion

Estate planning is not just for the rich – it is for anyone who wants to look after their family. A testamentary trust with the Section 4(q) deduction allows you to avoid tax upon your death, support your spouse, and ensure that your children get their share later. It is a clever way to keep hard-earned assets in the family. Speak to an expert to do it right, and you will have peace of mind knowing that your loved ones are protected.