In this installment on our series on trusts we investigate the basics of what every financial planner, estate planner, attorney and tax practioner should know about trust owned policies.

Trusts and the utility and use of Trusts have again become a hotly debated topic. The South African Receiver of Revenue, The Ministry of Finance and our courts have of late taken a keen interest in a number of areas pertaining to trusts. The latter attention from the heavyweights has justifiably sent most advisers reeling and advising clients to avoid trusts when the opposite is really the case, merely means that advisors need to familiarise themselves with the latest developments pertaining to trusts.

There are many and varied issues to canvass on this topic but we will limit our focus on a few key areas, namely the estate duty savings advantages of properly structured life assurance policy, the protection of the policy and the proceeds of the policy, the liability for estate duty estate on the death of the assured and lastly the tax consequences on the event of restructuring of a policy.

It is common knowledge that the proceeds recoverable from a life policy on the death of an individual is deemed property in the estate of the individual.

The above basically means that most insurance policies, save for certain specified policies, taken on the life of an individual will be deemed to be “property” forming part of the deceased’s estate for the determination of any estate duty payable. The deceased estate will potentially be subject to estate duty at the rate of 26.6% on any amount in excess of the R 3.5 million abatement amount. The latter appears quite inequitable as often the policy is not payable to the deceased estate.

There is however some relief as set out in section 3 (3) (a). Other than the section 4 (q) spousal relief, in the event that a policy is proposed by a person other than the deceased, e.g. a trust, then all the premiums paid on the policy plus a 6% interest per annum calculated from the date of inception of the policy to the date of death of the assured shall be deducted from any potential estate duty due.

This benefit is available if a person other than the deceased is the owner of the policy, pays the premiums on the policy and further is the person entitled to recover the proceeds of the policy, i.e. the beneficiary. In conclusion on this point, in the event that an individual is exposed to potential estate duty, relief may be obtained by structuring the life policy to be owned by a trust. This benefit must be considered when dealing with any client even more so a high net worth individual.

The next issue to consider when investigating whether to utilise a trust to own a life policy are the asset protection benefits. Very often advisers and their clients do not assess the impact of Capital Gains Tax, creditors and a host of other potential claims against the deceased estate, which could render the estate of the deceased insolvent or unable to pay the debts of the deceased estate or any potential estate duty that may be due. The latter scenario could render any proceeds which would have been payable under the policy to the estate attachable by creditors.

A frightening scenario which arises since the introduction of capital gains tax is the following: Mr. X acquires an asset in December 2001 for R 1 million, at the time of Mr. X’s death in 2020 the asset is worth R 15 million rand, in the intervening period Mr. X geared the asset to the extent of R 14 million rand. Capital gains tax would be levied on the difference between R 1 million and R 15 million, resulting in a CGT liability of R 1.4 million (ignoring exemptions and rollovers). The resultant effect is that the estate is insolvent due to the CGT liability. Interesting situation!

Coupled with the above, if the deceased had a life policy for an amount of R 5 million rand, which would pay to a major child as a beneficiary, this would trigger estate duty on the R 5 million less the R 3,5 million abatement. The estate is clearly insolvent, but would be liable for any estate duty. The executor or SARS would be able to recover the duty from the beneficiary. If the proceeds of the policy are to be paid to the deceased estate this would result in the entire proceeds of the policy being absorbed by the CGT, estate duty and possibly any other creditors. The position that has been presented can be easily avoided in the event that the assets are properly structured and ensuring that the policy is trust owned.

If you thought that the above is a frightening scenario, imagine that the beneficiary of a policy is a minor and both parents pass on in the same calamity, this would result in the proceeds if any being held by the guardians fund until the minor reached majority. Depending on how the policy is structured, any proceeds on such policy could be susceptible to a claim by a creditor and certainly SARS. The latter position can simply be avoided by ensuring the policy is trust owned.

Another possibility to consider when advising a client is the scenario where the intended recipient beneficiary is a major facing a financial crisis or a divorce, or simply being a person who is not very astute when dealing with financial issues or matters. It is common knowledge that many beneficiaries simply squander the proceeds or are duped into poor investment decisions, a properly structured trust will ensure that this does not transpire. The obvious issue when assisting a client is to avoid the proceeds of the policy which would have provided for an intended beneficiary being attached by a creditor of such beneficiary, again this can simply be avoided by ensuring that the policy is correctly structured in a solid trust.

Another clear benefit of a correctly structured trust owned policy is that the proceeds will also be protected from any potential future estate duty in the hands of the would be recipients, due to the fact that the proceeds recoverable under the policy would be held by the trust instead of in the hands of the individual, which otherwise would give rise to potential estate duty liability.

In the event that after a thorough financial needs analysis has been completed, and it is the interest of the client to restructure their life assurance, be warned that a new policy should be considered. The simple reason being that a mere cession of an existing policy will result in CGT in the hands of the person who is entitled to recover the proceeds of the policy on the stipulated event as the policy would be a second hand policy. This begs a further question, what to do with and elderly client or a client with a pre-existing condition, which would make it expensive difficult or impossible to get a new policy? Very simply the benefits listed above would need to be weighed up against the CGT liability.

On the basis of the above information one needs to consider whether a proper financial needs analysis has been carried out or conducted if the issue of a trust owned policy has not been canvassed.