In this advice column Robin Gibson from Harvard House answers a question from a reader who is concerned about his mother-in-law’s retirement planning.
Q: I live on a small farm with my wife. My mother-in-law, who is presently wheelchair bound, lives in a cottage on the property. She has been widowed for some time, and has never managed finances, or even driven a car, during her entire life.
When her husband died she converted most of his investments and property into cash and lumped all R5 million of it into her bank account. She retains a house in a family trust, which is rented out. The income is paid to her as one of the trustees.
She currently holds nearly R4m in her FNB bank accounts, with some relatively inconsequential stock investments. We would like to advise her to invest some of these funds, but the question is, in what?
She is ‘suspicious’ of investing with financial houses and has a bit of a ‘cash under the mattress’ mentality. She believes that upon her passing, up to 50% of her cash wealth will be seized by the state in death duties, and wants to do something to leave a legacy for her children and grandchildren.
Would another property make sense? There are rumblings of a South Africa not doing too well down the line, so why would one invest here when one can invest offshore too? Is that perhaps a better consideration?
A: As always, we are limited in answering such questions because we are unable to ask the specific questions that would frame our advice. In this case we are not aware of the age or income required by your mother-in-law from these cash reserves. However, a few common principles will be pertinent.
The issue with cash is always going to be the ability to maintain or grow your wealth relative to inflation as cash is a poor vehicle for this over any sustained period. Again the seriousness of the situation will depend on whether your mother in law is closer to 60 or 90 years of age. In addition the ability to beat inflation will also depend on whether she is using the income to live or reinvesting it for further growth.
Estate duties are a long-held fear for many South Africans. In reality, however, the truth is far from the fiction many create. As an individual, your mother-in-law is entitled to bequeath dutiable assets, net of allowable estate expenses and liabilities, up to the value of R3.5 million before she is required to pay any estate duty. Thereafter she will pay 20% of any amount dutiable.
In addition, should her predeceased spouse have not claimed his full R3.5 million abatement, any amount not claimed by him may be added to her abatement. Since it is likely that she inherited all her husband’s assets outright, it is also likely that her abatement could then be as much as R7 million.
The detail provided is insufficient to be sure, but we can state with certainty that she will not lose 50% of her estate in duties.
In respect of investing in another property, there may be several advantages:
Firstly, the growth of value in property that is well maintained and in a good area generally exceeds inflation over the medium to longer term. Property can also provide a regular growing income stream, in the form of rental.
Another advantage is that the process of buying and owning property is transparent, and the owner is largely in control of their own investment directly. This is especially important for individuals who are suspicious of financial institutions or investment products.
That said, property can have distinct drawbacks, especially for older and less mobile individuals. It’s important to bear in mind that landlords are held responsible by municipalities for any outstanding tenant costs such as electricity or water. This would be the case if the tenant absconded without notice.
Property also requires ongoing maintenance and fixed property is especially vulnerable to tax- hungry administrations in the form of rates increases. Tenants also seldom maintain a property to the same level as a property owner, and a tenant who pays poorly can leave the owner in a seriously negative cash-flow position.
It’s worth considering that liquidity can be a problem too, as you cannot ‘cash in’ a portion of your property.
Owning property in a Trust has been popular in the past. A Trust can be a particularly useful vehicle to manage the financial affairs of someone who degenerates into dementia, for instance.
In addition, since moving cash generates no Capital Gains Tax event, transferring and investing in the name of the Trust is certainly an option. That said Trust accounting can be expensive, and in addition, poor management of Trust affairs by inexperienced parties can lead to taxation at the highest rate of Income Tax and in some cases the maximum Capital Gains Tax rate.
Finally, investing funds offshore is an option should you be concerned about ‘SA Inc.’ going forward. Unfortunately though, it is highly likely that the best avenue to achieve such a goal would be one of the investment products that your mother-in-law appears to so vehemently opposed to.
With all that said, I would suggest that you take the following approach:
Consider consulting an accredited Certified Financial Planner who charges an hourly fee to propose some growth alternatives and address these issues in greater detail. Ask him or her to explain the mechanics of building a balanced growth portfolio using investment products such as low cost index funds, a discretionary managed share portfolio with rand hedge exposure, and a selection of low cost unit trusts. Specifically request that he avoids the recommendation of a ‘wrapper’, which only escalates the complexity and the cost of the investment.
*Robin Gibson CFP ® is a director of Harvard House Investment Management.
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