Diminished mental or physical capacity affects a significant portion of the elderly population. Statistics reveal that dementia affects one in twenty individuals over the age of 65 and one in five over the age of 80. According to DementiaSA, for every one person with dementia, five other lives are inevitably affected because of the need for care and support.
The financial planning process must therefore give due consideration to the management of a client’s or a loved one’s affairs in the event of mental or physical incapacity. Foresight ensures that the appropriate solutions are in place and/or anticipated to address potential challenges that may lie ahead.
Proactive financial planning is essential and acknowledges the realities of aging and potential health issues. It should aim to protect and manage a client’s or loved one’s financial well-being and affairs effectively even in the face of diminished capacity.
Strategies
(prior to mental impairment)
Powers of Attorney
Powers of Attorney may assist a person who has a physical impairment and is unable to attend to their financial affairs in person, even though they are still mentally competent. A Power of Attorney is a legal document where a person (the principal) gives authority to another person (the agent) to act on their behalf when it comes to personal matters such as banking, investments, legal matters, or business affairs. It can also cater for the specific needs of the principal. For instance, the principal can confer authority on the agent to manage their bank account only, thereby limiting their powers. Powers of Attorney are cost efficient; they have no ongoing costs; and can be revoked by the principal at any time.
Considerations
Powers of Attorney have certain limitations. South African law does not recognise an enduring Power of Attorney and therefore it falls away if the principal becomes mentally incapacitated.
A special trust Type A
A special trust Type A is an effective estate planning tool to safeguard and manage a person’s affairs in the event of mental and/or physical incapacity. This is an inter vivos trust which is established during an individual’s lifetime while they still have mental capacity. It can be converted to a special trust Type A once the person suffers from a disability as envisaged by Section 6B(1) of the Income Tax Act of 1962 (ITA).
According to the Act, the disability must substantially limit the founder’s ability to function or perform daily activities due to physical, sensory, communicative, intellectual, or mental impairments. It requires a confirmed diagnosis by a registered medical practitioner; the impairment must be irreversible and permanent in nature; and must have existed for at least 12 months.
A special trust Type A can be established to benefit multiple individuals with disabilities, provided that these beneficiaries are relatives of one another within the third degree of consanguinity.
To establish a special trust Type A for tax purposes, trustees must submit specific documentation to the South African Revenue Service (SARS), including an IT777TR form, the trust deed, and a medical report confirming the founder’s disability and inability to manage their own affairs or earn an income.
From a taxation perspective, special trusts Type A enjoy favourable rates compared to ordinary trusts. They are subject to income tax rates ranging from 18% to 45% and are aligned with those for natural persons. In addition, special trusts Type A benefit from an annual capital gains tax exclusion of R40 000 and a primary residence exclusion of R2 million on capital gains.
What to note when setting up a trust of this nature:
Trust structure
Assets may be transferred to the trust either as a donation or by way of an interest-free loan.
Tax implications
According to SARS’s Binding Private Ruling 384 and Binding Private Ruling 306, no donations tax will be levied on special trusts when assets are transferred for the founder’s benefit. SARS further stated that transfers of this nature are not made out of generosity or benevolence but are intended solely for the founder’s benefit during their lifetime. Proceeds of such a transfer will be equal to the face value of the relevant asset and as a result, no capital gain or loss will be realised.
Timing of asset transfer
The transfer of assets should occur while the founder is mentally competent.
Trustee selection
The trustees need to be carefully selected as they will be responsible for managing the trust assets and making decisions.
Trust deed
The trust deed must clearly define the duties and responsibilities of the trustees to prevent any ambiguity as they will have full control over the distribution of income and capital.
Continuation of the trust
The trust deed can make provision for the trust to continue after the death of the last-dying disabled beneficiary, although in such a case, it will no longer qualify as a Type A trust and will be taxed as a normal trust.
Considerations
- It is crucial to be aware of specific limitations that certain investment products may present in respect of special trusts. One notable example is a living annuity, which, according to Section 37A and 37B of the Pension Funds Act 24 of 1956 and SARS’s Binding General Ruling 58, cannot be transferred, assigned, reduced, or hypothecated to a third party. This means that a living annuity cannot be transferred to a special trust, nor can the living annuity income be paid to the special trust’s bank account.
- Some may establish an inter vivos trust with the intention of later converting it to a special trust in anticipation of a potential disability. This approach carries an inherent risk: If the anticipated disability does not materialise, the expense of setting up the trust, coupled with the 45% tax rate, can be a significant financial burden.
Strategies
(post mental and/or physical impairment)
Curator bonis
In terms of South African common law, when a person becomes mentally or physically incapacitated and is unable to manage their own affairs, a family member or loved one can seek relief by way of a Rule 57 application in the High Court. This application is made for the appointment of a curator bonis, whose role is to manage the financial affairs of a mentally and/or physically incapacitated individual.
The court requires substantial evidence demonstrating the extent of the incapacity, typically supported by medical and clinical reports. This evidence is crucial for the court to determine whether the individual indeed lacks the capacity to manage their affairs independently. The application must also name the person proposed for the role of curator bonis. This could be a family member or an independent third party, such as a legal practitioner (attorney or advocate).
Pursuing such a legal remedy can be financially burdensome. The costs associated with an application for the appointment of a curator bonis can be substantial, typically amounting to R100 000 or more. The current prescribed fee for a curator bonis is 6% of the annual income of the estate and a once-off fee of 2% of the capital in the estate when the curatorship ends (i.e. on death). These expenses are usually covered by the estate of the incapacitated person.
Once appointed, the curator bonis operates under strict oversight. All actions taken on behalf of the incapacitated person must receive prior approval from the Master of the High Court. This oversight ensures that the curator bonis acts in the best interests of the patient, although it can also lead to delays that may frustrate the decision-making process.
The powers granted to a curator bonis are strictly defined by the court in the order of curatorship (i.e. the ability to change nominated beneficiaries on investments). However, in practice these powers usually include managing and administering assets; making decisions on business activities; acquiring property for the benefit of the estate; using estate funds for the maintenance and support of the person; and investing estate funds prudently to benefit the estate.
A curatorship application typically takes 10-12 weeks subject to the availability of court dates. The application can also be brought on an urgent basis.
Considerations
A curator bonis application is costly, and family members may be reluctant to incur this cost, taking into account the value of the individual’s assets.
Administrator
Where an individual suffers from mental illness or incapacity, an application can be brought in terms of Section 63(3) of the Mental Health Act 18 of 1973 (Mental Health Act). This type of application is more cost-effective than a curator bonis application in that it is made to the Master of the High Court who has the authority to appoint an administrator to manage the property of the mentally incapacitated person, with costs being around R15 000. Where the value of the mentally incapacitated person’s estate exceeds R200 000 and their income is above R24 000 per year, the Master will request that an investigation be conducted before an administrator is appointed – a process designed to protect the interests of the person who is alleged to be mentally incapacitated.
The process begins with completing Form MHCA 39, the official application required under the Mental Health Care Act. This form must be submitted with two medical certificates confirming the diagnosis and prognosis. The application should also include details about a client’s or loved one’s assets, property and income, as well as information about the person best suited to manage their affairs. The appointment of an administrator typically takes at least 14 days from the date of the application.
Considerations
While appointing an administrator can be useful and cost-effective, it is important to bear in mind that only those who meet the narrow definition of mental illness or intellectual disability as set out by the Mental Health Act qualify for this type of assistance. As such, this mechanism is not available to those who cannot manage their affairs due to a physical handicap, terminal illness or old age (without dementia).
Conclusion
Navigating the options available to manage mental and/or physical incapacity demands proactive financial planning and legal foresight. Each approach carries distinct benefits, possible restrictions and limitations that should be carefully considered.
Understanding these options, their implications and the legal frameworks that govern them, is crucial for safeguarding the interests of a client or a loved one amidst the challenges posed by mental and/or physical incapacity.
