Question

My mother recently passed away and I will be inheriting a living annuity that pays her an income of R20 000 a month  and is worth R5m.

I have been given the option of taking the R5 million as a lump sum or to receive a monthly income.  I understand there are tax implications and need some guidance as which is the better option.

Answer

I can’t give you an authoritative answer without understanding your personal circumstances better. For example, I would need to know what income you are currently receiving, your current marginal tax rate, your current retirement savings as well as any short term capital needs.

I will, however, go through the pros and cons of each option which should help make a more informed decision.

Take the inheritance as a lump sum

If you take the capital value as a lump sum, it will trigger retirement lump sum tax.  Now the amount of tax that you pay will depend on whether your mother had taken a lump sum when she took out the living annuity. 

If your mother had not taken a retirement lump sum, then the tax that you would pay on the R5 million would be around R1.5m.  The calculation is shown below:

If your mother had previously taken a large lump sum, then the R5m would be taxed at a rate of 36% so the tax payable would be R1.8m.  You would therefore get out an after tax amount of R3.2m which you could use as you wish.

As this is after tax money, any investment that you make with these proceeds will only trigger capital gains tax.  This can provide you with a tax efficient income in the future

Take the inheritance as an income

If you take the inheritance as a living annnuity where you receive the income, you will not pay any tax on the capital amount.  The full R5m will be transferred to a living annuity in your name.  In addition, it will continue to grow in a tax free environment.  This is a fantastic benefit and a great way to build your family’s long term wealth.

You are obliged to take a minimum income of 2.5% a year from this living annuity.  This will be taxable at your marginal rate.  If you do not need the additional income, then I would recommend that you reinvest this additional money into a retirement annuity in order to remain in a tax neutral situation.

The big advantage of going this route is that it will make a massive difference to your retirement income when you do stop working. I do a lot of retirement counselling and regularly come across situations where the retirement savings are not large enough to provide the kind of income that the retired person would like to have.  By boosting your retirement savings by R5m and having this grow till you retire, you will be teeing up yourself and your family for a high level of financial security in the future

As with many financial decisions, the answer will probably lie in taking some of the money as a lump sum and the balance as an annuity.  I would recommend that you speak to a financial advisor who is skilled at doing these types of calculations and help you set up the correct structure.