Question

I was told that I need to have cash or a dedicated life insurance policy to pay estate duty when I die. Is this true?

Answer

It can be true, but it depends on the structure of your estate. The real issue is whether your estate will have enough cash available when it is needed. This is called liquidity.

SARS, the executor and other service providers all need to be paid in cash. Your heirs may eventually inherit valuable assets, but the estate still needs to get through the administration process first.

When someone dies, there are usually three main costs to consider:

• estate duty
• capital gains tax (CGT)
• executor’s fees.

Estate duty is a tax on the value of your estate when you die. It is paid by your estate before the assets are distributed to your heirs. In South Africa, each person has a R3.5 million estate duty abatement. In simple terms, the first R3.5 million of your dutiable estate can pass free of estate duty. Estate duty is then charged at 20% on the dutiable estate up to R30 million, and 25% above R30 million.

There is also important relief for spouses. If you leave assets to your surviving spouse, those assets are generally deductible for estate duty purposes. This means that, in many cases, no estate duty is payable on the first death if everything is left to the surviving spouse.   But this does not mean the tax has disappeared. It has usually just been delayed.  When the surviving spouse later dies, there is no spouse to inherit the assets. At that point, estate duty may become payable in the second estate. This is why estate planning must always look at both deaths, not only the first death.

Capital gains tax works differently.  When you die, SARS generally treats you as if you sold your assets at market value on the date of death. This is known as a deemed disposal. It can trigger CGT on assets such as investment portfolios, shares, unit trusts, business interests and property.

Again, there is relief when assets are left to a surviving spouse. Where assets are left to a spouse, the CGT is usually rolled over. In plain English, the CGT is normally not paid on the first death. It is carried forward and may become payable when the surviving spouse later sells the asset or dies.

So, on the first death, if everything is left to the surviving spouse, estate duty and CGT are often not the biggest problem. The more immediate problem is cash flow: will the surviving spouse have enough money to live on, and will the estate have enough cash to pay the executor fees for winding it up.

Executor’s fees are often the cost people forget about. The standard executor’s fee is 3.5% of the gross estate, plus VAT. This works out to 4.025%. So, on a R10 million estate, the executor’s fee could be about R402,500 before other administration costs are considered. 

Executor’s fees can often be negotiated, especially where the estate is large. It is worth dealing with this in your will while you are still alive. This matters because the work required to administer a R20 million estate is not necessarily double the work required to administer a R10 million estate. The value of the estate may have doubled, but the administration work has not necessarily doubled.  So, for larger estates, it can make sense to negotiate a sliding scale executor’s fee upfront. For example, the executor may charge one percentage on the first part of the estate and a lower percentage above that. This needs to be agreed in advance and recorded properly.

If you leave anything to your children when you die and your spouse is still alive, estate duty and CGT will be payable on those assets.  There is no rollover till the surviving spouse passes away.  This can create liquidity issues.  However, for most couples, the only big cost that will have will be executor fees.

I would recommend that you ask your financial planner to calculate the various fees and taxes that would be payable if you and your spouse were to pass away.  They would prepare a dummy liquidation and distribution account as if you died today and calculate what would happen.

The calculation should show what your estate is worth, what debts must be paid, what executor’s fees may apply, whether CGT will be triggered, whether estate duty will be payable, how much cash will be available, and whether there will be a shortfall. Once you know this, you can make sensible decisions.

A good estate plan should answer these questions:

• Who needs cash when I die?
• Where will that cash come from?
• Will my spouse be financially secure?
• What costs will the estate have to pay?
• Will my heirs receive their inheritance without unnecessary delays or pressure?

The goal is simple: when you die, your family should not be left scrambling for cash, negotiating under pressure, or making rushed decisions at the worst possible time. A good estate plan makes sure that the right amount of cash is available, in the right hands, at the right time.