It is important that you structure your financial matters in an estate duty-friendly manner, Jenny Gordon, a senior legal adviser at Old Mutual, told a recent meeting of the ipac/Personal Finance Investors Club in Johannesburg. In the second part of our report on Gordon's presentation, we look at some of the methods you can use to reduce estate duty.
There are a number of ways to reduce your estate duty liability and you should discuss these with your estate planner, Jenny Gordon, a senior legal adviser at Old Mutual, says.
Gordon says you should seek specialist advice to assess whether an estate-duty saving technique is appropriate to your circumstances.
Here are some of the methods that can be used to reduce estate duty:
Insurance policies
In general estate duty must be paid on life policies, but certain insurance policies are free of estate duty if structured correctly. These include:
- The proceeds of properly-structured buy-and-sell policies paid into an estate. These are policies in which business partners or shareholders insure each other's lives in order to buy out each other's shares on death. To qualify as estate duty-free, no premiums must be paid by the person whose life is assured, and the parties must be co-owners of the business at the date of death;
- The proceeds of key person insurance, which covers the life of a "key" person in a business. The proceeds paid into an estate will not be dutiable if: a policy is taken out by a business on the life of a director or employee, unsolicited by the latter; no premium is paid by the employee or director; and the policy proceeds are not paid to the employee or director or their relatives or a family companies;
- Policies taken out because of a promise or obligation in an ante-nuptial contract; and
- Where somebody takes out a life policy on another person's life, pays the premiums and is entitled to the proceeds. In this case, the dutiable value of the policy is reduced by the premiums paid and six percent compound interest. Often a trust that buys an asset on a loan account takes out a policy on the planner's life in order to repay the loan on the planner's death.
The R1.5 million abatement
Every estate qualifies for exemption from estate duty on the first R1.5 million of assets, and no estate duty is payable on assets you leave to your spouse (this includes common-law spouses and same sex partners). So, if you leave everything to your spouse, you are wasting the R1.5 million estate duty abatement. Although your estate will not pay estate duty, the payment of duty on all your assets is postponed until your spouse dies.
For example, your estate is worth R5 million and your spouse's estate is worth R1 million. If you leave everything to your spouse, his or her estate will be worth R6 million when you die. On your spouse's death, his or her estate will make use of the R1.5 million abatement, and pay estate duty on R4.5 million. At a rate of 20 percent, the estate duty will be R900 000.
However, you can bequeath R1.5 million directly to your children or to a trust (free of estate duty because of the abatement), and the balance of R3.5 million to your spouse (also free of estate duty because it is left to a spouse).
On the death of your spouse, he or she has an estate of R4.5 million (R1 million plus the R3.5 million he or she inherited from you). Your spouse's estate can make use of the R1.5 million abatement, which will reduce the dutiable estate to R3 million. Your spouse's estate will then only have to pay estate duty on R3 million, which amounts to R600 000 - a saving of R300 000.
Retirement Products
Estate duty is payable on benefits paid as a lump sum from pension, provident and retirement annuity funds. When benefits are paid in the form of a compulsory annuity (pension, including a living annuity), the annuity does not attract estate duty. So, when retiring from a retirement fund, consider taking the full pension instead of one-third as a lump sum.
Money in your estate which you intend investing to generate an income in retirement, for example, cash in a money market fund, can be contributed to a retirement annuity fund before the age of 70, thereby saving you estate duty on this money.
If you use the full benefit you receive from your retirement fund to purchase a compulsory annuity at retirement age, you will have reduced the value of your estate for estate duty purposes by this amount and any growth earned in the retirement annuity fund.You may also qualify for certain income tax deductions.
Donating R30 000
You and your spouse can each donate R30 000 to a trust annually, free of donations tax. In this way, you can reduce the value of the assets in your estate, and any growth in the donated assets takes place within the trust.
The trust can then take out an investment in its name with an annual premium of R60 000 - the sum of the amount you and your spouse can donate without paying donations tax.
In later years, if you and your spouse need money, subject to the trust deed, you may be able to borrow money from the trust. If you have not repaid this loan by the time you die, it will become a liability in your estate and will further reduce your estate for estate duty purposes.
Transferring assets to a trust: estate pegging
Assets are transferred to a trust in one of two ways. You can donate assets to the trust (but donations tax will be payable on any donations over R30 000), or you can sell the assets to the trust. Usually, you will allow the trust to owe you the purchase price and a loan account is created. The loan is usually repayable on demand or death, whichever occurs first.
Sometimes the trust takes out a life policy on your life in order to repay the loan to your estate on your death. You can bequeath the balance of the loan account to the trust on your death. The value of the loan remains estate dutiable in your estate, but any growth on the asset sold takes place in the trust and is removed from your estate for estate duty purposes. The trust can repay the loan account over your lifetime providing for you to live on at retirement, and the value of the loan is then gradually reduced in your estate for estate duty purposes.
Gordon says if you are going to be one of the trustees of the trust, it is important to have at least two other trustees, otherwise tax legislation may regard any assets donated or sold to the trust as being yours anyway, because you control the trust. You should appoint experienced and expert trustees because the law places onerous responsibilities on trustees.
Gordon warns that many people start using a trust too late in their lives for estate pegging purposes - for instance, they wait until they have retired. Most of the growth in your assets has already taken place by then and you are likely to use any future growth to live on.
Using trusts
There are other good reasons for using a trust for estate planning, other than for estate pegging purposes: You can save on executor's fees; a trust facilitates the quick distribution of assets to beneficiaries during the winding up of your estate; it protects your assets against creditors and insolvency; it provides confidentiality of your financial affairs; and it protects your assets for the benefit of minors, handicapped dependants and spendthrift heirs.
Other reasons for wanting to use a trust for estate planning are for the joint ownership of indivisible assets (such as a farm); for the running of your business after your death; and avoiding the costs of successive administration of estates by providing for successive beneficiaries. Trusts also provide an immediate source of funds for your dependants when you die and trustees can provide professional services.
There are also disadvantages to using a trust. These include: a loss of control over your assets; there are costs involved in setting up and running a trust; and there are no tax advantages for you during your lifetime (the benefits are only realised after your death).
The taxation of trusts
Trusts pay income tax at a flat rate of 40 percent, and there are no rebates. Trusts also pay CGT at an effective maximum rate of 20 percent (the rate for individuals is a maximum of 10 percent), and there are no exemptions or rebates.
Where a trust takes out a life policy, the life office pays the CGT on behalf of the trust and no further CGT is payable when the policy matures.
Where beneficiaries are entitled to income or capital held by a trust - by virtue of the trust deed or the discretion exercised by the trustee - the beneficiary is responsible for paying income tax and CGT on the benefits received. This is called the conduit principle. It means that income earned by a trust that is distributed to a beneficiary in the same tax year is taxed once only and retains its nature when it passes to the beneficiary.
So, if a trust earns interest and distributes the interest to the beneficiary in the same tax year, the beneficiary will be taxed and the beneficiary's tax rate will apply, not the trust's.
If a trust distributes the proceeds of a policy to the beneficiary in the same tax year that the proceeds are received, the distribution to the beneficiary will be tax-free as it would have been for the trust.
If you transfer assets to a trust you should be careful of certain tax avoidance rules under which you can become liable for income tax and CGT, even though the income and capital gains accrue to the trust or its beneficiaries. This applies whenever there has been a donation the trust.
Offshore trusts
Gordon says you must be very careful if you use an offshore trust. Our trust laws could differ considerably from the trust laws in other jurisdictions, which could result in our courts or tax authorities refusing to acknowledge the existence of such a trust.
The taxation of offshore trusts is complex and there are several provisions in tax legislation that may result in an unexpected tax liability for you.
The bottom line with offshore trusts is that you should not take them on without the assistance of a team of trusted experts, Gordon says.