Know The Possible Limitations When Setting Up a Family Trust

A family trust is a popular estate planning tool in South Africa, offering a range of benefits such as asset protection, wealth preservation, and tax efficiency. However, while family trusts can be incredibly useful, they also come with certain disadvantages that should be carefully considered before setting one up.

1. Loss of Control Over Assets

One of the most significant disadvantages of a family trust is the loss of direct control over assets. When you transfer assets into a family trust, you no longer personally own them—the trust becomes the legal owner. While you may still be a beneficiary and can influence decisions through the trustees, the control you had as an individual owner is diminished.

This can be especially challenging for business owners or individuals who are used to making swift, independent decisions about their assets or investments. Any major decisions regarding the trust’s assets, including buying or selling property or making investment changes, must be made by the trustees. This can lead to frustration or delays, especially if the trustees have a different approach or strategy from your own.

2. Complexity and Administrative Burden

Setting up and managing a family trust can be complex and require ongoing administration. The process of establishing a trust involves legal documentation, creating a trust deed, and appointing trustees. Trustees have fiduciary duties to manage the trust responsibly, and their actions must align with the trust deed and the law.

This administrative burden often leads to additional costs, including:

  • Professional Fees: Legal and accounting professionals are often required to establish and manage a trust properly. These costs can quickly add up, particularly if the trust holds substantial assets.
  • Ongoing Management: Trustees must ensure that proper records are kept, tax returns are filed, and financial statements are up-to-date. This requires time and effort, and failing to comply with legal and tax requirements can lead to penalties.

For individuals looking for a more straightforward approach to asset management, a family trust may not be the ideal solution due to its complexity and need for continuous oversight.

3. High Tax Rates on Trust Income

Trusts in South Africa are subject to specific tax rates that may not be as favorable as those applied to individuals. For instance, trusts are taxed at a flat rate of 45% on income exceeding R1.73 million (for the 2024/2025 tax year). This is higher than the income tax rate for individuals, which can be as low as 18%, depending on the income bracket.

Although income can be distributed to beneficiaries to reduce the tax burden, there are still tax implications to consider:

  • Capital Gains Tax (CGT): Trusts are also subject to CGT, which is applied at a rate of 36% on any capital gains made. This is a higher rate than that applied to individuals, which may range from 18% to 27.3%, depending on the amount.
  • Distribution Strategy: While income distribution can lower the overall tax burden, it can also complicate tax planning. If not carefully structured, the trust may face higher taxes due to the flat trust tax rates or lead to unintended tax consequences for the beneficiaries.

This high tax burden is one of the key disadvantages of a family trust and requires careful management to minimize the impact.

4. Difficulties in Modifying the Trust

Once a family trust is set up, it is difficult to change. The terms of the trust are laid out in the trust deed, which acts as a binding legal document. Making changes to the trust—such as altering the distribution plan or amending the trustee structure—often requires legal approval and may be complex.

If the trust is irrevocable, it cannot be easily altered or undone, even if your circumstances change. This can become problematic if you wish to update the terms of the trust due to changes in family dynamics, financial situations, or tax laws. As a result, you may be locked into the initial terms of the trust for the long term.

This rigidity is something to consider, especially if you anticipate needing flexibility in the future.

5. Risk of Family Disputes

A family trust is often established with the goal of preserving family wealth and ensuring fair distribution among heirs. However, in some cases, it can lead to conflicts or disputes between family members. If the trust’s terms are unclear or perceived as unfair, it can cause friction and damage family relationships.

Common sources of disputes include:

  • Disagreements Over Trustees: If the trustees are family members, there may be conflicts about how the trust’s assets should be managed or distributed.
  • Perceived Inequities: Beneficiaries may feel that the distribution of assets is unfair, especially if certain family members receive more than others or if the conditions of inheritance are seen as restrictive.

To mitigate these risks, it’s crucial to establish a well-thought-out trust deed and engage in clear communication with family members about the trust’s purpose and provisions.

6. Costs of Transferring Assets Into the Trust

Transferring assets into a family trust can have associated costs, particularly for high-value assets such as property or businesses.

  • Donations Tax: When you transfer assets to a trust, you may be liable for donations tax. The donations tax rate is currently set at 20% for the first R30 million and 25% for amounts exceeding that threshold. This can be a significant financial burden if you’re transferring valuable assets into the trust.
  • Transfer Costs: For real estate and other assets, the transfer process can incur registration fees, legal costs, and taxes. These costs can make the process of setting up a family trust prohibitively expensive for some individuals, especially those with substantial assets.

7. Limited Flexibility in Business Operations

If you own a business and decide to place it in a family trust, the trust becomes the legal owner of the business. This can limit your ability to make decisions or change the structure of the business without involving the trustees. If you wish to sell the business or take on investors, this could lead to additional complexity and potential delays due to the need to consult with trustees or beneficiaries.

Additionally, the business may be subject to higher tax rates on any profits that are retained in the trust, further complicating the financial structure.

While a family trust offers numerous benefits, such as asset protection, estate planning, and tax efficiencies, it also comes with potential drawbacks. The loss of control, complexity, tax implications, and the possibility of family disputes are important considerations before setting up a family trust in South Africa.

At Burger Huyser Attorneys, we specialise in providing tailored legal advice to help individuals and families make informed decisions about estate planning and asset management. If you are considering setting up a family trust, contact us today to discuss how we can guide you through the process, address the potential disadvantages, and ensure that your trust aligns with your goals and objectives.

Contact Burger Huyser Attorneys, and book a consultation.

To speak to one of our experienced attorneys in South Africa for immediate assistance, contact us on the numbers below:

Randburg call 061 516 6878; Roodepoort call 061 516 0091; Sandton call 064 555 3358;  Pretoria call 064 548 4838;

Centurion call 061 516 7117; Alberton call 061 515 4699; Bedfordview call 061 536 3223

DISCLAIMER: Information provided in this article does not, and is not intended to constitute legal advice. READ MORE