Retirement annuities (RAs) are a great vehicle for estate planning now that there is no age limit on contributions, Tiny Carroll, an estate planner at Sanlam’s Glacier division, says. He says normally the focus with RAs is on saving income tax. Few people think about the estate-planning opportunities. Two of the essential elements of estate planning are:
* Reducing your exposure to taxes, which include estate duty, donations tax and capital gains tax (CGT); and
* Ensuring that your surviving family members have sufficient income to maintain their standard of living.
Carroll says: “The combination of estate duty and CGT payable at death poses a threat to the value of your estate. RAs give you the opportunity to make additional provision for your retirement together with the potential for saving income tax, estate duty and CGT, as well as ensuring you and/or your dependants have a protected income at death or retirement.”
Carroll says the scrapping three years ago of the age limit on contributions to an RA has a two-fold benefit for people who are over the age of 69. You can join an RA fund to:
* Reduce the tax on your monthly taxable income, and/or
* Reduce the dutiable value of your estate.
Carroll says when you die the full proceeds (benefit) of an RA may be taken as a lump sum or as an annuity (monthly amount), or a combination of these, by your beneficiary/ies.
He says the Estate Duty Act excludes retirement benefit lump sums and annuities from the estate of a deceased person. This covers all tax-incentivised retirement savings, be they in an occupation fund, a preservation fund or a RA fund. As a result, every rand contributed to an RA fund is removed from your estate.
Coupled with this, the restriction on lump-sum benefits on the death of a fund member has been removed from the Income Tax Act. The beneficiary of the RA is now allowed to take the entire benefit in the form of a lump sum.
Any benefit taken in the form of an annuity (a regular payment) will be added to the gross taxable income of the annuitant (beneficiary) and taxed as such as part of the annuitant’s (beneficiary’s) income. Any lump sum will be taxed in terms of the lump-sum scales for the retirement fund.
Carroll says it usually makes sense to take the first R300 000 as a lump sum when the beneficiary qualifies for this tax-free amount.
He says normally an RA member should not exceed the maximum contribution limits, as there would be no tax advantages. At retirement you can add any excess payment to the tax-free amount, but over the years the value in real, after-inflation terms will have diminished.
It is better to rather save any additional amount in a non-tax-incentivised savings vehicle such as a collective investment scheme.
However, Carroll says, if you have a shorter life expectancy and want to do what is called “emergency estate pegging”, then you can consider paying in amounts into a RA in excess of the 15-percent maximum that you may deduct from your taxable income in any one tax year.
Note that the 15 percent is limited to the portion of your income in excess of the 7.5-percent maximum – if you are a member of an occupational retirement fund – of your pensionable income you are permitted to deduct in any one year. So, say you earned R500 000 a year of which R300 000 was what is called “pensionable income” and the balance was made up of a travelling allowance, commissions and bonuses, you could deduct from your taxable income retirement fund contributions of 7.5 percent (R22 500) of your R300 000 “pensionable income” and 15 percent (R30 000) of R200 000 “non-pensionable” income.
Carroll says although you cannot deduct from your taxable income any extra amount paid over the limits, there is no prohibition on paying in extra. The one time it can work is when you have a shorter life expectancy and you face a large estate duty liability on death.
However, for anyone who is simply in old age, you need to be careful with your decision and must take account of such things as the initial estate duty rebate of R3.5 million (2010/11 tax year) and the after-inflation value of money if you are blessed with a long life.
An example:
Mr X contributes R1 million to an RA and dies four years later. The RA’s value at death is R1 500 000.
If his beneficiary takes the benefit (and assuming no other fund benefits) as a lump sum, the entire benefit will be free of estate duty. The saving of 20-percent estate duty on R1 500 000 is R300 000, assuming the initial R3.5 million duty exemption has been used.
But the amount will be subject to the retirement fund lump-sum taxation, namely the first R300 000 (the tax concession) plus R1 million disallowed contribution being tax-free. The balance of R200 000 would be taxed at 18 percent. The tax payable is R36 000 – a saving of R264 000.
Carroll says that if you die after you have converted the RA to an annuity (pension) and have selected an investment-linked living annuity in which your beneficiaries are entitled to the residual capital, then those beneficiaries will have the option of electing an annuity or commuting the annuity for a lump sum.
If an annuity is selected, it will be taxed at the marginal rates of the beneficiary. If the annuity is commuted, the lump-sum benefit will be taxed according to the deceased member’s tables – thus allowing the use of any disallowed contributions or any part of the R300 000 which has not yet been used, Carroll says.