In terms of our law of succession, testators and testatrixes in South Africa enjoy the freedom of testation, subject to very few limitations, with a number of mechanisms available to them to ensure that the wealth they have built during their lifetime can be transferred from one generation to the other.
When it comes to wealth creation, most people have as one of their goals the desire to leave a financial legacy to their children or loved ones, making succession planning an essential exercise to undertake. Importantly, succession planning should take place holistically and with a view of your entire estate – both local and offshore – to ensure that no conflicts, confusion, or omissions occur. Effective succession planning starts with identifying your various assets, who you wish those assets to be transferred to, and the most appropriate, tax-efficient manner of doing so.
In this article, we explore the various mechanisms available to transfer assets from one generation to the next.
A last will and testament
The structuring of your Last Will & Testament is the first step in developing a succession plan, although it is important that this document is not drafted in isolation from your overall plan. There are many factors that influence the manner in which your will can be structured – such as your maintenance obligations, duty of support and matrimonial property regime – and it is never a good idea to have your will drafted in isolation from the rest of your planning.
Through the creation of a valid will, you are able to appoint a trusted executor to administer your estate, set up a testamentary trust to house assets intended for your minor beneficiaries or special needs children, create special bequests, and nominate heirs to your estate. The structuring of your will can also be used to reduce estate duty and to ensure that there is sufficient liquidity to cover your estate costs.
If you have offshore assets, your financial planner should be in a position to advise whether or not you require a foreign will in respect of those assets, and this will generally depend on the type of assets you hold offshore and in which jurisdiction they are held. Remember, assets held in civil law jurisdictions such as France, Spain, Portugal, the Netherlands and Mauritius, may be subject to mandatory succession rights, otherwise known as ‘forced heirship’, which place a restriction on how your wealth can be distributed – generally with a view to protecting the spouse and children of a testator.
For instance, non-residents of France who own property in that country are subject to their succession law rules. This means that assets do not automatically pass in accordance with your will, and children are protected heirs and can inherit up to 75% of your estate. In Spain, forced heirship is a legal feature that requires those who pass away under Spanish laws to bequeath two-thirds of their estate to their children. Mauritius also has forced heirship rules in respect of non-residents who own immovable property in that country, with children being the protected heirs.
Trusts make excellent estate planning vehicles and are used regularly to house, protect, and ensure the succession of assets to the next generation. Whether to use an inter vivos or testamentary trust to give effect to your succession plan depends on a number of factors including the nature of the asset, the age of the intended beneficiaries, and the intention for which you envisage the asset being used.
If you have minor children that you nominate as your heirs, then it makes sense to set up a testamentary trust in your will. In the event of your passing, the trust will come into fruition and any assets bequeathed to the trust will be transferred into this entity to be managed by your nominated trustees.
On the other hand, if you have fixed property in the form of a holiday home or family farm that you intend to leave to your children, you may want to explore using an inter vivos trust to house such assets. Because property of this nature will generally increase in value over time, the effects of CGT and estate duty will increase the costs of transferring the property to your children. By purchasing such assets in a living trust where your children are the beneficiaries, the asset effectively never sits inside your personal estate, and your children receive the asset without having to incur unnecessary taxes.
Special trusts, which can be set up as testamentary or inter vivos trusts, are worth mentioning in circumstances where an estate planner has a beneficiary with a severe mental or physical disability and who is unable to manage their own financial affairs. This form of trust can be useful where an estate planner has a special needs child or a spouse who has been diagnosed with dementia, especially when it comes to safeguarding assets and ensuring that those beneficiaries are not taken advantage of.
In order to qualify as a Type A trust, the trust must be set up in terms of Section 6B (1) of the Income Tax Act, and the beneficiary must qualify as a special person in that they must have a disability that limits their ability to function or perform daily activities, and the disability must be permanent in nature. If set up correctly, such a trust will enjoy tax rates applicable to natural persons ranging from 18% to 45%. In addition, the annual CGT exclusion of R40 000 is available to this trust, as well as the primary residence exclusion of R2 million of the capital gain on disposal for CGT purposes.
Another mechanism that can be used to give effect to your succession goals is donations, although it is important to keep in mind that Sars makes provision for a Donations Tax threshold of R100 000 below which no Donations Tax is payable. Thereafter, tax is calculated at a flat rate of 20% on the value of the donation up to R30 million, and at a rate of 25% on donations over and above R30 million.
Estate planners can therefore effectively use their annual R100 000 threshold to move assets into a trust during their lifetime so as to reduce their estate duty liability, although it is important to fully understand the effects of moving assets into a trust in terms of loss of control. Donations between spouses are not subject to tax, as are bona fide contributions made towards the maintenance of a person, and donations towards any sphere of government or registered political party.
When it comes to transferring assets in line with your philanthropic or charitable goals, Section 18A of the Income Tax Act makes provision to donate up to 10% of your taxable income towards a registered Public Benefit Organisation. So, if your intention is to transfer some of your wealth to your favourite charity or organisation during your lifetime, you are able to do so in a tax-efficient manner provided that you are in possession of a Section 18A certificate granted by the Tax Exemption Unit office of Sars.
If you have a large portion of your accumulated wealth invested in your business, then it is important to consider what will happen to your business interests in the event of your death. It is likely that you intend for the value of your business interests to provide your spouse and/or children with a source of income in the event of your passing. To ensure that the surviving shareholders are in a financial position to purchase your interests should you pass, you may want to consider taking out business assurance as a method of funding such a buy-out.
Buy-and-sell insurance entails taking out life cover on each shareholder’s life based on the value of the company and in proportion to their shareholding. If correctly structured and supported by a business assurance agreement, the proceeds of a business assurance policy will not attract estate duty in the deceased’s estate and, having said that, it is always advisable to have one’s business assurance structured by an expert in this field.
Another mechanism for ensuring effective succession planning is by nominating beneficiaries to your life policy or living annuity. If you wish to provide capital to your spouse and/or children in the event of your death, taking out life cover is an effective method of achieving this. Remember, however, that the proceeds of a life policy where a beneficiary has been nominated, subject to a few exceptions, will be considered deemed property in your deceased estate and will be subject to estate duty which must be taken into account when determining the correct quantum of cover you require.
On the other hand, beneficiary nomination on a living annuity allows you to ensure the succession of invested capital to your spouse or child, with the added benefit that the value of the living annuity does not form part of the estate when it comes to calculating estate duty. Nominating your loved ones as beneficiaries to your living annuity also gives them almost immediate access to capital without it having to go through the estate administration process and possible delays.
From an estate planning perspective, retirement annuities are advantageous in that they are tax-efficient both during your lifetime and on your death. Your contributions towards your retirement annuity are tax-deductible, and any growth on the value of your fund is tax-free. In addition, retirement annuities fall outside of your deceased estate and are not subject to estate duty.
That said, the impact of Section 37C of the Pension Funds Act – which regulates the distribution of retirement fund benefits on the death of a member – must be understood in the context of your plans for succession. In the event of your death, it is the retirement fund trustees who are responsible for determining how your retirement funds will be distributed after a process of establishing who your financial dependants are. This means that, while you are able to nominate a beneficiary on your retirement fund, this nomination is merely taken under consideration by the trustees when making a determination as to the distribution of the funds. Based on their investigations and findings, the retirement fund trustees will make a determination and allocation in respect of the fund distributions, and this may not necessarily be in line with your intentions.