A primary function of estate planning is to put measures in place to reduce the estate duty liabilities in one’s estate so as to enhance estate liquidity and maximise the financial legacy for your loved ones. There are a number of products available which, if correctly structured, do not attract estate duty. In this article, we explore these various mechanisms and how they can be incorporated to reduce tax in one’s estate.
The proceeds of pension, provident, preservation, and retirement annuity funds do not fall into a deceased estate and, as a result, do not attract estate duty. This is because these retirement benefits fall within the ambit of the Pension Funds Act and the distribution of these benefits is tightly governed by Section 37C of this Act. While a retirement fund member can nominate beneficiaries to their investment, it remains the responsibility of the retirement fund trustees to determine how the deceased’s benefits should be distributed amongst his financial dependants. Before doing so, the trustees are required to undertake a process of identifying all the deceased’s financial dependants – including spouses, children, aged parents, siblings, and anyone else who is entitled to maintenance or who can be considered financially dependent on the deceased. In making their determination, the trustees will take into account the nominees on the deceased’s policy, although this will only be used as a guide. Once the award has been made, the funds will be distributed to the identified dependants, meaning that the capital will bypass the deceased’s estate and will avoid estate duty.
Estate planning tip: When developing your estate plan, keep in mind that while the proceeds of retirement funds are excluded for estate duty purposes, there are limitations on your ability to distribute the proceeds as you deem fit. Priority will be given to those who are financially dependent on you, either wholly or in part.
Living annuities make excellent estate planning tools because the policyholder is free to nominate their beneficiaries with the surety that, upon their death, the proceeds will devolve on them. In the event of the policyholder’s death, the proceeds of the policy are not part of the winding-up process and, as such, become almost immediately available to the beneficiaries, thereby circumventing the deceased’s estate and avoiding estate duty.
Unlike retirement funds, the policyholder can nominate anyone to their living annuity, meaning that financial dependence is not a requirement. The nominated beneficiaries can choose how they wish to receive the funds in the living annuity. They can either choose to make a full withdrawal, subject to tax, or transfer the full amount to another living annuity in their own name. Alternatively, they can elect to make a partial withdrawal taking advantage of the deceased’s tax-free amount of R500 000 if this limit had not previously been fully utilised and transferring the balance into a new living annuity.
Estate planning tip: If you fail to nominate a beneficiary to your living annuity, the proceeds of the policy will be paid into your estate but will not attract estate duty. However, keep in mind that your executor reserves the right to charge fees on these funds. Thus, if your intention is to use the proceeds of your living annuity to create estate liquidity, do not forget to account for potential additional executor’s fees.
Buy and sell assurance
While the proceeds of domestic life insurance policies are considered deemed property in a deceased estate, buy and sell cover is a notable exception. Buy and sell cover is insurance taken out by business owners on each other’s lives so that, in the event that one shareholder dies, the proceeds of the policy will allow the surviving shareholders to purchase the deceased’s business shares.
In order to qualify for an estate duty exemption, it is essential that the buy and sell policy is correctly structured and appropriately supported by a valid buy and sell agreement. As such, the buy and sell cover must be taken out by a person who is co-owner of a business with the deceased at the time of their death. Further, the policy must be taken out specifically so that the surviving shareholders can use the proceeds to purchase the deceased shareholder’s shares in the business. The structuring of the policy must be such that the premiums must not be paid by the deceased shareholder.
Estate planning tip: The buy and sell agreement must set out the details of what will happen in the event of a shareholder’s death, the funding mechanism for share purchase (being the buy and sell cover), the timeframe in which the transfer should take, together with details of the shareholders and business valuation. Ideally, employ the services of an experienced professional to set up buy and sell cover and to construct an agreement that is fully aligned.
Key person assurance
Similarly, the proceeds of a key person policy, if correctly structured, can be exempt from attracting estate duty in the deceased’s estate. Typically, key person assurance is taken out on the life of a key person to minimise business risk in the event of that person’s premature death or disability. When structuring the policy, the company taking out the policy must be the nominated beneficiary and must be responsible for paying the premiums. If the key person dies, the proceeds of the policy will be paid directly to the company, meaning that the proceeds bypass the deceased’s estate and do not attract estate duty.
Estate planning tip: To be exempt from estate duty, the company that owns the policy must not be a family company in relation to the life assured.
Domestic policy where your spouse is the named beneficiary
Section 4(q) of the Estate Duty Act makes provision for the value of all property accruing to the surviving spouse to be deductible from the gross estate of the deceased, thereby avoiding estate duty. Notably, this includes the proceeds of a domestic life policy where the surviving spouse is the named beneficiary – keeping in mind that the definition of ‘spouse’ in this context includes a permanent life partner. In such circumstances, the proceeds of the life policy will be paid directly to the surviving spouse or life partner without attracting estate duty or executor’s fees.
Estate planning tip: Where a domestic life policy is registered against an ante-nuptial or post-nuptial contract where the spouse and/or minor child are nominated beneficiaries, the proceeds of such a policy do not form part of the deceased’s dutiable estate. Because this type of policy would need to be registered against the couple’s marriage contract, this would only apply where the couple is legally married in terms of the Marriage Act or the Civil Union Act and would not apply to life partners.