182 - Tax-savvy tips around estate duty and other fees

Question

I am an 80 year old widow and have R5m investment that will be maturing shortly.  This provides me with an income of R33 000 a month on which I pay R5 000 in tax.  As I also own a property, I am concerned that should I pass away, this R5m investment will result in R1m being paid in estate duty by my children.

How can I invest the R5m in order to pay the least amount of estate duty?

Answer

The situation is a little worse than you mentioned, in addition to the R1m in estate duty, the investment will also result in over R200 000 being paid in executor fees.

I have a solution that will provide you with a tax free income while you are living and significantly reduce any estate duty that your heirs will have to pay.

There are several moving parts so I would recommend that you speak to an experienced financial advisor to ensure that it is structured correctly to ensure that you get all the benefits.

There are three legal principles that I will be using in order to reduce your estate duty liability:

• Retirement funds do not form part of your estate.
• If you contribute more than 27.5% of your income into a retirement annuity, the excess contributions (also known as disallowed contributions) will not trigger estate duty if your beneficiaries take the proceeds as an annuity.
• The income that your draw from living annuity that is funded by a disallowed contribution to a retirement annuity will not be taxable in your hands as it will be classed as a capital drawdown.

The investment would be structured as follows:

You would use the full R5m to buy an RA which you would mature immediately and use the proceeds to set up a living annuity.  This is sometimes referred top as a “1 day RA”.

Any contribution to a retirement annuity that is above 27.5% of your taxable income will be classed as a disallowed contribution.  The income that you draw from the disallowed portion of a living annuity will not attract income tax.  This means that if you drew your R33 000 a month from this investment, you would not have to pay R5 000 a month in tax. This is a great way to structure your finances in order to reduce is that you pay on your retirement income.

What is nice about investing in a living annuity structure is that you have unlimited choice in the types of portfolio that you are investing in. You can also attach a beneficiary to receive the proceeds which means that the benefit can be transferred very quickly without waiting for your state to be finalized. In addition, as the executor will not be handling these funds, there will be a saving over around R200 000 in executor fees.

Should you pass away, your beneficiaries will have two options on how to receive the proceeds of this living annuity: 

• if they take it as a lump sum, there would be no tax payable on the remaining disallowed contributions, however, estate duty will have to be paid on the remaining disallowed contributions in the investment
• if they choose to receive the proceeds as an annuity, then no estate duty will be payable but the income they take would be taxed at their rates. 
• The annuity that they take can be between 2.5% and 17.5% of the capital value.  While they are still working, I would recommend that they take an income of 2.5% and allow the funds to grow in the background.  The income will be taxable in their name although they can make an equivalent payment into an RA in order to remain in a tax neutral situation.

By going this route, the inheritance can provide them with a fantastic engine to ensure that they have a comfortable retirement and provide their children with a substantial inheritance.

Insider tip

Consider leaving some of the living annuity to your grandchildren. As they Are probably not taxpayers, the bulk of the annuity will not trigger any income tax in their hands. It will also provide them with an ongoing reminder of the grandparent.

There are a couple of smaller items that your planner would need to do attend to in order to ensure that you receive all the benefits of this structure.  However, the solution outlined above should result in a significant saving in terms of income tax and fee leakage from your estate.