Each and every case must be considered on merit. Having said that, one would need to carefully consider the implications of such an action before embarking on the process of replacing individually owned policies with trust owned policies when it comes to personal financial planning requirements.
Factors to consider
Will the Section 4(q) deduction be lost?
Where a spouse was the nominated beneficiary and that nomination is changed to a trust, then the section 4(q) deduction (of the Estate Duty Act) could potentially be lost and proceeds could become liable for duty. The amount taken into account as deemed property may be reduced by return of contributions plus 6% per annum if the trust is both the payer and beneficiary. In only very limited and specific circumstances will the section 4(q) deduction be retained. Essentially, losing the section 4(q) deduction could mean that as much as 20% to 25% of the proceeds could be lost to SARS in the form of estate duty. It also means that you should increase the sum assured to cater for this additional tax.
Does the trust have a bank account?
In order for the trust to be the payer, it must have a bank account. This is a prerequisite for a trust in terms of the Trust Property Control Act, and yet so many trusts do not have one. Making sure that the trust has a bank account, will also ensure that payment of the proceeds is not delayed in the event of death of the life assured. Take into account the fact that the trust needs to actually have the liquidity to pay the premiums. Neither of these factors should be accepted as a given.
Who will ultimately benefit from the proceeds?
Policy benefits pay to the policyholder, which would be the trust. That means that the trustees acting within the constraints of the trust deed, decide how and to whom to distribute the benefits. Consider whether the life assured is in fact a trust beneficiary, and if so – what kind of beneficiary – income and/or capital? This is particularly relevant when benefits other than life cover is included in the policy.
How much, if any, of the proceeds of the policy will ultimately be paid to the person who has suffered the permanent disability, impairment or dread disease? Does the assured person actually want these benefits to pay into the trust and does he fully understand the implications thereof? What happens if the consent of all the trustees is required to deal with an asset and the life assured (who is in a coma) is one of the trustees and is unable to give that consent?
How is the spouse affected if the policy proceeds and all other assets are bequeathed to a trust?
The surviving spouse will be restricted by the decisions of the trustees. The income or capital received will in many instances always be at the discretion of the trustees and he/she will therefore not enjoy financial independence. This could hinder his/her ability to perform basic financial transactions as he/she may never have a guaranteed fixed income – he/she may not even be able to open a clothing account in his/her own name! Consider the financial transactions that require proof of income in order to glimpse how debilitating this can be. Unless there are extraordinary circumstances at play, the surviving spouse should be permitted a degree of financial independence and consideration should be given to some benefit being paid directly to that person.
What are the fees that will be incurred by the trust?
The independent trustee may charge a fee based on assets under management. That means on an annual basis the trustee will receive a percentage of the value of all the assets (including the proceeds of the life insurance policy) held by the trust. Consider this in the context of the planner who establishes a trust to reduce his costs, taxes, etcetera, upon his death. The trustee’s fees are seldom fixed for the long term; upon the planner’s death, these fees could amount to considerably more than anticipated. Add to this, while it is not a legislative requirement, if the trust deed so provides then the trust must be audited – more fees and costs that must be added to the equation.