BEWARE OF LOAN ACCOUNTS IN TRUSTS
By Andró Griessel
7 June 2025
Trusts have been used for decades as an effective way to manage multi-generational family wealth into the future, but also to protect assets from creditors, including, I dare say, especially the South African Revenue Service (SARS).
There has been much discussion around the tax benefits of a trust, primarily relating to estate duty advantages, of course, but also regarding income tax and capital gains tax, especially when the conduit principle is applied.
You’re taxed at 45% within a trust itself, which makes it highly inefficient when income or capital gains are taxed inside the trust. However, thanks to the fact that interest, rental income, or capital gains earned by the trust can be distributed to the underlying beneficiaries, and then taxed in their personal capacity (hopefully at a lower rate), trusts have long been considered highly favourable vehicles for tax planning.
This principle, however, has gradually led to a new problem for certain family trusts over the past decade or two, namely: large loan accounts in the names of children or very young adults, resulting from profits, rent, or interest that was allocated to them (for tax purposes) but never physically paid out, therefore remaining as amounts owed to them by the trust.
If your family trust currently finds itself in this position, I’d like to highlight the following key points.
Tax Returns
For years, distributions could be made to minor children, and as long as they fell below the taxable threshold, you could possibly get away without submitting a tax return for the minor or other beneficiary.
However, SARS’s systems have become more sophisticated, and allocations to beneficiaries must now be accompanied by a return for that specific beneficiary.
Johan Jacobs from Initium Accountants adds the following:
“The fact that, if distributions were made from a trust that was funded on friendly terms by the minor children’s parents, the parents are technically supposed to declare the income in their own tax returns (section 7(3) of the Income Tax Act)—and that this is largely ignored.”
Reverse Impact on Estate Planning
Particularly where family wealth is substantial, large annual distributions can result in significant assets being accumulated in the name of a very young person at an early age. This, of course, has the opposite effect on that person’s own estate planning compared to what the previous generation may have intended to achieve.
Death
What happens to the loan account if the beneficiary dies?
If the beneficiary dies without a will, it will revert back to the parents through inheritance.
However, if Peter is newly married or has a will that leaves everything to his girlfriend or fiancée, then she would inherit that loan account (as an asset) and could have a legal claim against the trust.
In one of the trusts where I raised these questions with the accountant, the response was that the trustees could reverse the distribution in such a case, due to a clause in the trust deed that gives them the discretion not to distribute.
I have a feeling that, in practice, things might not play out quite as neatly as the theory suggests.
Beneficiary tax bracket
The moment the beneficiary starts working, any allocations to them push them into a higher tax bracket than they would normally fall into.
Cash Shortfall
There are two issues at play here.
First, is there enough cash in the trust to settle the loans if it ever becomes necessary?
Second, what if a beneficiary insists on having their loan paid out—would the argument that the distribution can simply be reversed still stand?
Once again, the clause giving trustees discretion comes into question, but as mentioned earlier, I find it difficult to see how you can hide behind that in practice.
Jacobs adds: “As soon as a child is no longer a minor, the trustees ought to ensure that the beneficiaries are aware of the distributions made to them.”
Alternative Strategies
Take another look at your trust’s financial statements under the section titled “Undistributed Allocations.”
If substantial amounts are listed under your children’s names, it may be wise to consult your accountant about how best to deal with them.
Here are a few alternative strategies, or possible remedies, for this pain point:
- Pay your children’s expenses (school fees, studies, car, and so on) from the trust and offset these costs against the loan, in order to repay it as quickly as possible.
- Consider putting wills in place for your children that ensure the loans are bequeathed back to the trust. However, keep in mind that if they are already married, such a bequest back to the trust could fully or partially use up their section 4A estate duty exemption, which may not be in the best interest of the surviving spouse or their own children.
- If the trust’s income primarily comes from renting out property or land, and the primary beneficiaries of the trust (the parents) don’t need that income because they still earn salaries or have other sources of income, don’t be too eager to eliminate the “debt” against the property or properties.
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The interest is deductible against the rental income, which reduces the need to distribute income or to pay tax on it.
.Of course, this should be approached with careful consideration, weighing the return on alternative investments against the net after-tax cost of the loan.
- If the trust holds investments with a substantial interest-income component or significant capital gains implications (typically trusts with large equity and/or unit trust fund holdings), consider using a “sinking fund” structure where the income is taxed at 30% within the investment vehicle itself.
.Importantly, no income distribution needs to take place, so there’s no need to increase the loan accounts.
- If the trust has the funds to settle the loan accounts and doing so won’t compromise the care or financial security of the primary beneficiaries (the parents), but the trustees are concerned that the children won’t use the distributions wisely, consider contributing the funds to retirement annuities on their behalf.
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They will only gain access to the money once they are 55 or older, and they’ll receive a tax credit that can be usefully applied over several years.
.This also avoids creating an immediate potential estate duty issue.
In conclusion: Loan accounts are like runaway trains — you’ve got to deal with them while they’re still a dot on the horizon. Wait too long, and they’ll flatten you before you can blink.
Andró Griessel is a Certified Financial Planner at Woodland Wealth. Contact him at info@woodlandwealth.co.za.