LIVING ANNUITY: BE AWARE OF THE TAXES WHEN YOU DIE

One must be mindful of the conditions that render them ‘non-taxable’.

The general perception is that living annuities and products like retirement annuities, preservation funds, and corporate retirement funds do not form part of your estate and, therefore, do not attract executor fees or estate duty when you die. While this holds true, one must be mindful of the conditions that render them “non-taxable”. Get it wrong, and taxes in the form of withdrawal fees of up to 36% will be levied…

Retirement funds, in general, and this includes corporate retirement funds and retirement annuities, are the most dynamic investments that an individual can make, contrary to much negative publicity about retirement annuities in particular. If one considers the tax deductibility of the contributions, the tax-exempt status of the returns and no capital gains tax on portfolio switches, the benefits and potential growth far outweigh the negative aspects of Regulation 28 constraints that govern pre-retirement products/funds. Granted, income will be taxed the day you retire, but once again, the additional capital you accumulated due to the favourable tax treatment and the lower tax bracket that you should be in at retirement justifies optimising contributions to pre-retirement products.

Don’t spend years benefiting from all the tax advantages of contributing towards retirement funds just to give it all back because a few simple rules were not adhered to.

Structured correctly, retirement annuities, as well as other retirement vehicles, offer one of the most dynamic estate planning tools.

I want to distinguish between pre-retirement products like corporate retirement funds and retirement annuities compared to post-retirement products like living annuities. It is important to understand what laws and acts govern each product. Pre-retirement products (corporate retirement funds, preservation funds and retirement annuities) fall under the Pension Funds Act. Living annuities fall under the Income Tax Act.

Why is this important?

• Where pre-retirement products are applicable, you do not own your “retirement fund”; you are a member of the particular retirement fund together with a larger pool of many other members. This also applies to retirement annuities. The trustees of the fund will determine who will ultimately receive what proportion of the fund value, irrespective of who you nominate as your beneficiaries. They will use your beneficiary nominations as a guide, but there is no guarantee that your nominated beneficiaries will receive proceeds as you requested.

Since the trustees decide who inherits, no executor fees will apply to pre-retirement products and by nature, products that fall under the Pension Funds Act do not form part of your estate, so no estate duty will be applicable. However, taxes will apply on amounts that are commuted to cash based on the retirement tax tables as they apply to the deceased retirement fund member taking previous retirements and withdrawals into consideration. Retirement taxes are tiered with an upper limit of 36%. These taxes can be avoided if the receiving parties transfer the proceeds to a preservation fund or a retirement annuity or if they invest in a post-retirement product like a living or a life annuity, which they can do if they are over the age of 55. Those who take the cash will bear the brunt of the applicable retirement taxes.

• Since living annuities fall under the Income Tax Act, you, as the individual, are responsible for the nomination of your beneficiaries. There are no trustees who decide how your funds are invested (no Regulation 28 constraints) or how the proceeds get distributed. Both these obligations fall squarely in the lap of the annuitant. The insurance company that underwrites the living annuity will act 100% according to your nominated beneficiaries without question. Payout is swift and efficient as long as you have nominated beneficiaries. As a matter of interest, a trust can also be nominated as a beneficiary; however, care must be taken. Depending on who the ultimate beneficiaries of the trust are, trust taxes (income tax) of 45% may apply to the income received. Once again, if any amount is commuted to cash, the retirement tables will apply.

Living annuities have been granted the same status as pre-retirement retirement products as far as estate duty is concerned, with an exemption and an exclusion from the annuitant’s estate.

• The problem arises when no beneficiary is nominated on the living annuity. In this case, the proceeds will be paid to the annuitant’s estate after deducting the required retirement taxes, which once again can be as high as 36% depending on previous withdrawals and commutations. Now the executor will have to allocate the proceeds according to the annuitant’s will, thereby attracting executor fees that can be as high as 3.5% + Vat.

A further complication where no beneficiaries were nominated is the time it will take before the proceeds are distributed to estate beneficiaries. Distributions can only take place after the executor is appointed by The Master and after the final distribution account is submitted. At best, this will be after six months, but it can take several years. If the living annuity was a major asset of the annuitant and there were financial dependants reliant on the proceeds, financial hardships would more than likely occur.

Where beneficiaries nominate to invest their proceeds in a new living annuity or a compulsory life annuity, no retirement taxes will apply.

Taking the above into consideration, it is important to sit your beneficiaries down and discuss the implications of their decision on how they wish to receive the proceeds from your living annuity.

Try and convince them to retain the proceeds in a living annuity in their own name since that will be the most tax-efficient option. It will also go a long way to boost their future retirement funding.

If you have not commuted any proceeds to cash in the past, it makes sense for beneficiaries to draw the R550 000 tax-free portion in cash and invest the balance in a new living annuity or annuities where more than one beneficiary stands to inherit. Remember, the taxes and withdrawals apply to the deceased annuitant, not the nominated beneficiaries.

First and foremost, please nominate beneficiaries with urgency if you have not already done so.

It is also a good idea to nominate secondary beneficiaries on a living annuity in case a nominated beneficiary is not alive at the time when the annuitant dies. If no secondary beneficiary is nominated and the nominated beneficiary has since passed away, the proceeds will be paid to the annuitant’s estate and attract the applicable retirement withdrawal taxes.