Why Use An Endowment Policy To House A Trust
In many instances a trust has been an effective estate planning vehicle, particularly to reduce an investor’s personal estate by transferring assets to a trust, thereby reducing estate duty. However the taxation of trusts has recently become a burden on the vehicle as income tax rates and capital gains tax inclusion rates have steadily been on the rise.
Let’s look at the advantages of using an endowment policy as an investment tool within a trust structure.
Annual donations tax concession
Individuals are allowed to donate up to R100 000 to any person including a trust each year – for married couples (also people living in a permanent relationship, same sex or heterosexual) this means R200 000 per annum. Donations above the R100 000 exemption will be subject to donations tax of 20%.
Donations to the trust can be used by the trustees to fund the premiums on an endowment policy owned by the trust Section 7C applies to outstanding loan accounts due by the trust to the planner. It will only be relevant where the planner is using his annual donations tax free amount to write down the loan account due to him by the trust. In such a case he can’t do both the donation and the write down (subject to the section 7C provisions in the income tax act).
Tax advantages
Endowments can be very tax efficient vehicles for trusts in comparison to unit trusts collective investment schemes and cash deposits which saw an increase in income tax and capital gains tax rates from 1 March 2017. The tax efficiency of a trust owned endowment lies in five fund tax approach in terms of the individual policy holder fund. This essentially means that trust owned endowments receive preferential tax rates on growth within the fund and that the proceeds received from the endowment will be after tax payments and therefore tax free in the hands of the recipient.
Only applies to taxable interest element of CIS income retained in the trust
· If we look at the table above that’s a difference of 24% on CGT alone.
· After the endowment matures, proceeds from the endowments are not taxed.
· The proceeds from the endowment which are distributed to the beneficiaries or utilized by the trustee for the benefit of the beneficiaries will not have an effect on pushing up the beneficiaries’ marginal tax rate. This means that the marginal tax rate applicable to traditional annuity income is not increased,
· Additionally, in appropriate cases the “award” to a beneficiary from the trust can take the form of a loan/s. The loan debt owing to the trust will need to be settled from assets in the beneficiary-lender’s estate on his/her death, thereby creating an estate duty deduction which can be used to reduce the dutiable value of the planner’s estate. The planner’s living expenses in effect become an estate duty deduction. *Effective tax rates within the five fund approach did not change as of 1 March 2017.
Protection on Divorce or Insolvency
Up until retirement from a retirement fund a member’s benefit (pension interest) may, in terms of the Divorce Act, be regarded as part of his or her assets which are subject to division on divorce.
Trust assets will not be part of either party’s estate in the event of divorce – provided that the trust functions as a trust and that the ownership of trust assets vests in the trustees for the benefit of the trust estate and trust beneficiaries. If the trust is merely the alter ego of the “planner” the assets supposedly held in trust will may (I say may, because the courts are taking a new direction in this regard) be subject to division on divorce.
Like retirement fund benefits (protected once contribution is made whereas insolvency protection of endowments only kicks in after 3 years. If held in trust and the estate owner’s estate is sequestrated policy is protected, after 3 years trust assets in an endowment policy will not be attachable by creditors in the event of the planner’s insolvency. (The same proviso as above applies and the trust is set up correctly.)
