Life insurance can make an excellent estate planning tool to ensure succession, make provision for loved ones, and to create liquidity in one’s estate. However, it is important to understand the estate duty implications when it comes to life assurance policies because getting it wrong can have severe consequences for your estate and your loved ones.
Section 4q deductions
At the outset, bear in mind that in terms of section 4(q) of the Estate Duty Act, the value of all property which accrues to the surviving spouse is deductible from the gross estate of the deceased. This is the case whether the surviving spouse inherited in terms of intestate or testate succession, and includes the proceeds of any domestic life policy where the surviving spouse is the named beneficiary. The proceeds of such a policy are paid directly to the surviving spouse and therefore do not attract estate duty nor executor’s fees. The definition of ‘spouse’ in the context of section 4(q) includes a permanent life partner and not only a legal spouse in terms of the Marriage Act or the Civil Union Act.
A policy registered under an antenuptial contract
Where a domestic life policy is registered under an antenuptial or postnuptial contract where the spouse and/or child are the nominated beneficiaries, the proceeds of such a policy do not form part of the deceased’s dutiable estate. As such, no estate duty nor executor’s fees are payable on the proceeds. Naturally, as such a 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.
A policy owned and paid for by a third party
In circumstances where a life insurance policy is owned and paid for by a third party (i.e. someone other than the deceased), section (3)(3)(a) of the Estate Duty Act provides some relief in respect of the third-party payer’s premiums. By way of example, where a son takes out a policy on his father’s life, and where the son is the owner and payer of the policy as well as the nominated beneficiary, the proceeds of the life insurance policy will be considered deemed property in the father’s estate upon his death, less the total premiums that the son paid towards the policy, compounded at 6% per annum.
Buy and sell assurance
The proceeds of business assurance policies are not considered deemed property in a deceased estate and therefore provide an exception to the general rule when it comes to calculating the dutiable estate. To qualify for an exemption, the buy and sell insurance must be taken out by a person who is a co-owner of a business with the deceased at the time of their death. In addition, the policy must be taken out with the specific purpose of purchasing the deceased shareholder’s business interests, with the added proviso that the premiums must not have been paid by the deceased person.
Key person assurance
To avoid having the proceeds of a key person policy considered deemed assets in the deceased’s estate, such a policy must be correctly structured. Key person insurance is typically a policy taken out on the life of the key person in order to minimise risk to the business if that person died prematurely or became disabled. To be exempt from estate duty, the company which owns the policy must not be a family company in relation to the life assured, must pay the premiums and must be the nominated beneficiary on the policy. As such, if the key person passes away, the proceeds of the policy will be paid directly to the company and will therefore not be dutiable.
Endowment policies owned by the deceased which do not pay out on death will be considered property in the deceased estate. This includes both local and offshore endowments. As such, the surrender value of the policy is included.
Where a South African citizen is living in another country at the time of death, the proceeds of any South African life policies will be included in their deceased estate, subject to the exclusion rules. For instance, where a South African living abroad nominates his wife as the beneficiary of a domestic life policy registered in terms of their antenuptial contract, such proceeds will not form part of his dutiable estate. On the other hand, where his estate is the nominated beneficiary, the proceeds will be subject to estate duty.
Policies where the estate is the nominated beneficiary
Life insurance policies can be used to create liquidity in an estate where a person wishes to make capital provision for their spouse and/or children or to settle debt. In such circumstances, the policyholder would nominate their estate as the beneficiary of the policy, and the proceeds payable on death would form part of their dutiable estate. When determining one’s liquidity needs on death, it is therefore important to take into account the estate duty payable on the proceeds of such policies when determining the quantum of cover needed. Importantly, the nature of your marital regime will impact how the proceeds will be dealt with in your estate. If you are married with the accrual system, the proceeds of such a policy will form part of the accrual calculation. If you are married in community of property and your estate is the nominated beneficiary, the proceeds will form part of your joint estate in the event of your death. However, only 50% of the proceeds will be subject to estate duty with the balance accruing to your surviving spouse free from estate duty.
Life insurance can be a particularly complex area of estate planning and, while it can be useful in structuring your estate for the benefit of your loved ones, the correct structuring of the policy is essential to ensure it is fit for purpose. As part of your annual financial planning review, your advisor should re-visit your life insurance policies to ensure that the structuring, quantum of cover, and beneficiary nomination correctly reflect your wishes and intentions.