Question

I have R15m saved in a retirement annuity.  As I have sufficient income from other sources, I will not need these funds to provide me with the pension. I would like to leave the full R15m to my son who is about to start university.  How do I do this and how can I avoid paying estate duty?

Answer

You can nominate your son as the beneficiary of the retirement annuity. However, this will not guarantee that the full R15m will be paid across to him should you pass awa and the funds are still in the RA.  This is because retirement annuities are governed by the Pension Funds Act so the trustees of the retirement annuity fund must do a full check to see that there are no other deserving claimants on these funds.  This can result in delays in the transfer of the funds and the danger that your son may not get the full R15m.

There are ways around  this.  The  solution we choose  will  depend  on your age.

• If you are under 55

If you are under 55, you cannot mature your RA, so if you die, the trustees will hold the ultimate call as to what your son would inherit. 

What I would recommend in this instance is that you draft a note that expresses your wishes that your son should inherit the RA.  If there are other dependents and potential claimants, you can also mention how they would be taken care of in the event of your death.  You can give this to your financial advisor who could pass it on to the trustees of the retirement annuity fund.  It is not a foolproof solution, but it can go some way towards ensuring that your wishes are taken care of.

• If you are over 55

If you are over 55, I would recommend that you convert your retirement annuity into a living annuity. You must make your son the beneficiary. Should you pass away, the proceeds of the living annuity will be transferred immediately to your son. There will be no involvement of any trustees, so your wishes will be honored 100%.

With a living annuity, you are obliged to take a drawdown of at least 2.5%. I would recommend that you reinvest this money immediately into another RA.  This will ensure that you do not pay any tax on the income.  You should make your son the beneficiary of the second RA, so he won’t be losing any value.

When it comes to investing in a living annuity, you will have access to the full range of investment portfolios. You will not be impacted by any regulations that govern where you can or can’t invest your money.  The capital inside the living annuity will grow in a tax-free environment – there is no capital gains tax, no dividends tax and no income tax within the structure. It is a clean and efficient way to grow capital for the next generation

Should you pass away, your son can choose how he wants to receive the benefit.

• He can take a lump sum; however, this will trigger the retirement lump-sum tax which becomes expensive at higher amounts.
• The better option is to transfer it into a living annuity in his own name. Here the capital enters his hands tax-free and he only pays income tax on the drawdown he selects.  If he took a  drawdown of 4% on the R15m, he would receive a monthly income of around R50,000.  He  would have the ability to decrease or increase the drawdown percentage depending on his own personal circumstances.

Estate duty

Estate duty will be impacted by how the RA was funded

• Allowed contributions

If the retirement annuity was purchased by taking advantage of your annual retirement allowance of 27.5% of your taxable income,  then all the proceeds would fall outside of your estate.  

No estate duty would be payable at all, even regardless of whether  your son chose to receive the benefit  as a lump sum or as an annuity.  This is one of the few areas of estate planning where the legislation deliberately creates a tax-efficient intergenerational wealth transfer tool.

• Disallowed contributions

If the retirement annuity was purchased using funds that did not qualify for the 27.5% retirement allowance, it would be classed as a disallowed retirement contribution.

 As long as your son elected to receive the proceeds of the investment as an annuity, no estate duty would be payable.  If, however, he elected to receive the benefits as a lump sum, estate duty of at least  20% would be triggered.

Retirement annuities and living annuities are powerful tools for transferring wealth efficiently — the key is setting them up correctly. A bit of planning now will ensure that your son receives the full benefit of what you’ve built.