Would your heirs mismanage millions - when a testamentary trust becomes essential

Should your heirs have full, unrestricted control over your living annuity when you die?

Many people assume the biggest risk to their retirement savings is market volatility. In reality, the greater risk often only becomes apparent after death, when beneficiaries are not prepared to manage significant wealth. It is not usually about bad intentions. It is about readiness.

It is the son who has never managed a meaningful sum of money. The daughter who is highly capable in her career but struggles with financial discipline. The surviving spouse who suddenly has to make complex financial decisions alone. Or the beneficiary who sees an inheritance as a windfall rather than a responsibility. And what happens to minor children who can’t receive cash? Are the guardians capable of looking after their inheritance in a meaningful way?

As financial planners, significant effort goes into helping clients grow and protect their wealth. Far less time is spent considering what happens when that wealth passes into the hands of someone who may not be equipped to manage it effectively.

Inheritance is straightforward. Stewardship is not. Most estate plans focus on distribution: who receives what and in what proportions. That matters, but it avoids a more important question.

Will your beneficiaries be able to manage what you leave behind? Inheriting money and managing money require very different skills. It is not uncommon for wealth built over decades to be depleted within a few years, not through recklessness, but because the discipline and experience required to manage meaningful capital were never developed.

The flaw in ‘equal distribution’
‘Just leave everything equally to my children’ is a common instruction. The intention is fair. The outcome is not always. Equal inheritance does not lead to equal outcomes. One beneficiary may be financially disciplined, while another may struggle with impulsive spending. A beneficiary may face business pressures or creditor risk. A surviving spouse may experience declining capacity over time. In these cases, a simple division of assets does not account for very different personal circumstances.

In one example, a client was concerned about an adult son who had previously depleted two windfalls within a short period. The intention was not to exclude him, but to ensure some level of protection and structure. The question was not whether he was capable in general, but whether he was ready to manage a large sum without support.

Where a testamentary trust becomes powerful
A testamentary trust is often misunderstood. It is not only for the wealthy, nor is it primarily a tax strategy. At its core, it is a way to protect beneficiaries.

A testamentary trust is established in a will and only comes into effect after death. Instead of assets transferring directly to a beneficiary, trustees manage those assets according to defined terms. Income can be distributed when appropriate, while capital remains protected and is released over time or under specific conditions. This introduces continuity. The safeguards applied during one’s lifetime do not disappear at death.

Linking a testamentary trust to a living annuity
A testamentary trust can be nominated as the beneficiary of a living annuity. This means retirement capital does not need to be paid out as a lump sum to an individual. Instead, a living annuity is set up by the trust, providing a structured income stream that is managed within the trust.

For families with minor children, dependants with special needs, or beneficiaries who may not yet be financially experienced, this structure can provide ongoing stability as the trustees manage the investments.

Understanding the tax implications
Tax is often the first concern and rightly so. Trusts in South Africa are taxed at a flat rate of 45% for income retained by the trust, with capital gains taxed at an effective rate of 36%. Individuals are taxed on a sliding scale, with lower effective rates in many cases.

Where a trust is a beneficiary of a living annuity, there is no upfront tax when the new Living Annuity is set up. The trust becomes the owner of an annuity and remains subject to the same annual drawdown limits as a living annuity, between 2.5% and 17.5%.

Income from the annuity is taxed, either within the trust if the income remains in the trust or, in the hands of beneficiaries at their marginal tax rates if the income is distributed to them within the same tax year. This can result in a more favourable outcome.

Trusts that distribute income, for example to minor children, or special trusts established for disabled beneficiaries, may benefit from being taxed on the individual scale rather than at the flat trust rate.

Another benefit of using a trust for minor beneficiaries is that the living annuity can pay out any remaining balance in cash when the trust terminates. This normally happens when the beneficiary reaches the age of 18, 21, or 25. This rule is not available in other living annuities, which must run for the client’s lifetime or until the remaining amount falls below the de minimus amount. These technical considerations should be addressed with a qualified financial adviser.

Tax considerations alone should not determine whether a trust is appropriate. A testamentary trust is primarily a protection mechanism. If it preserves capital for the intended purpose, that benefit may outweigh the additional tax and management costs.

The real question
The central question in estate planning is often framed as who should inherit. A more useful question is how that inheritance should be managed over time. Ensuring that beneficiaries receive support, structure and guidance can be as important as the assets themselves.

Before confirming beneficiaries on a living annuity, it is worth asking a simple question. If your heirs inherited a significant sum tomorrow, would they manage it in a way that preserves its long-term value?

If the answer is uncertain, introducing a level of structure through a testamentary trust may not only be appropriate, it may be essential.