How to use financial products to enhance estate planning

Felicia Hlophe, Legal Advisor at Allan Gray, summarises four key estate planning principles and explains how some financial products can be used to provide a better outcome for beneficiaries.

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An estate consists of the assets and liabilities that an individual accumulates during their lifetime and leaves behind at death. An individual should create and manage an estate plan to preserve, grow and protect their assets during their lifetime and ensure that those assets are transferred to successive generations. An estate plan should be structured according to each person’s unique circumstances, goals and wishes and should be reviewed regularly to take personal and legislative changes into account.

Principle 1. It is recommended that every individual has a last will and testament

As with an estate plan, a will should be reviewed and updated to take account of any life changes. Individuals with foreign assets should also consider a foreign will. As each country has its own set of laws regarding succession and the drafting of wills, it is recommended that assistance be obtained from a professional in the foreign jurisdiction, such as a lawyer, to ensure that the foreign will is legally compliant. Where there is no valid last will and testament, the estate is dealt with in accordance with the Intestate Succession Act. When this occurs, the deceased’s assets may accordingly be dealt with in a manner that is not in accordance with their intentions.

Photo of Felicia Hlophe, Legal Advisor, Allan Gray
Felicia Hlophe, Legal Advisor, Allan Gray

In terms of the Intestate Succession Act, the estate must be divided between the deceased’s spouse and direct descendants, whereby the surviving spouse inherits the greater of R250 000 or a child’s share. A child’s share is determined by dividing the total value of the estate by the number of children plus the surviving spouse. If the deceased was married in community of property, one half of the estate goes to the surviving spouse and the other half devolves according to the rules of intestate succession. If there is no surviving spouse or descendant, the estate is divided between the deceased’s parents and/or siblings. In the absence of parents and siblings, the estate is divided between their nearest blood relatives.

A will should provide for the nomination of an executor to prevent a delay in winding up the estate. It is recommended that the will states that the executor be granted the power of assumption which will entitle them to appoint another executor should the need arise. According to the Administration of Estates Act’s tariff, an executor is entitled to a fee of 3.5% on the gross value of the assets in the estate and 6% on income accrued and collected after the death of the deceased. However, executor fees may be negotiated and set out in the will.

Another consideration is to nominate a legal guardian to take care of any minor children if both parents pass away and to provide for a testamentary trust for the administration of their inheritance. This is important because assets left directly to minor children who do not have a legal guardian may have to be transferred to the government’s Guardian’s Fund. The Fund will administer these assets until those children turn the age of 18.

Principle 2. Think carefully about financial products, estate duty and executor fees

The Estate Duty Act (“EDA”) provides that if the deceased was ordinarily resident in South Africa at the time of their death, their worldwide assets will be included for the purposes of calculating estate duty. Estate duty is levied at a rate of 20% of the dutiable amount of an estate up to R30-million and at 25% of the dutiable amount of the estate above R30-million. The value of the estate therefore needs to be estimated for estate duty purposes.

The dutiable value of a deceased estate is calculated by adding the value of the deceased’s property, deducting allowable expenses and then deducting the Section 4A rebate. The Estate Duty Act provides all individuals with an abatement of R3.5-million which is deducted from the net value of the estate for estate duty purposes. At this point, the estate is taxed. However, not all assets are estate dutiable.

The death benefits in a retirement fund are not considered property in a deceased estate. In addition, unless the death benefit is paid to the estate, which is not very common, the executor does not administer these assets, as they are distributed to the deceased’s financial dependants and/or nominees in accordance with Section 37C of the Pension Funds Act. Retirement products, can therefore be used to reduce estate duty and executor fees. However, any excess contributions that were made by the deceased to a retirement annuity fund, that were not deducted at the time of death for income tax, will be subject to estate duty.

Other financial products also provide some relief from estate duty. The following products are excluded for the purposes of calculating estate duty:

  • The proceeds of living annuity policies
  • Buy and sell policies that would be paid to a business partner for the purpose of funding the purchase of shares from the deceased
    Key person policies
  • Policies that are ceded to a spouse or child in terms of an antenuptial contract
  • To the extent that proceeds are paid to nominated beneficiaries, no executor fees are payable either.

There are also discretionary investment vehicles known as “policy wrappers” where no executor fees would be payable if there are nominated beneficiaries on these investments. For example, tax-free investments and endowments allow for beneficiary nominations where proceeds are payable to beneficiaries. Estate duty would still be payable with respect to both products; however, in terms of section 4(q) of the EDA, estate duty would not be payable should the surviving spouse be the nominated beneficiary. To the extent that estate duty is payable, the executor may recover such estate duty from the beneficiaries.

Principle 3. Account for beneficiaries’ liquidity needs

The process of winding up an estate can be lengthy and can put beneficiaries in a difficult financial situation if they do not have the means to cover their living expenses. There are various ways to ensure that cash will be available to beneficiaries while an estate is being wound up.

Taking out life insurance cover is a good way to provide loved ones with access to money and ensure that there is sufficient liquidity in an estate to pay for the estate duty liability and executor fees, and settle any outstanding mortgage bonds and other debts.

A living annuity can be used to effectively provide an income for beneficiaries. On the death of the policyholder, the proceeds are, at the election of the beneficiaries, paid as a lump sum and/or as an annuity, if they continue with the policy in their own names. Although estate duty is not payable on the value of the living annuity, the beneficiaries may be liable for income tax on the annuity income should they wish to continue the policy in their own names.

“Policy wrappers” that allow for beneficiary nominations can also assist with ensuring that the proceeds are not tied up in the estate, pending the completion of the winding-up process. The proceeds are available for payment to beneficiaries at their election. Some “policy wrappers” allow for a beneficiary for ownership to be nominated.

In other words, this beneficiary would take ownership of the policy on death. The beneficiary nominated for ownership would have the option to continue with the deceased’s policy in their own name or have the policy proceeds paid out. If the beneficiary decides to have the policy paid out, the proceeds will be received net of 12% capital gains tax, which will be deducted within the policy. Where the beneficiary elects to continue with the policy in their own name, it will be a capital gains tax roll-over event.

Principle 4. Ensure that all estate planning documents are reviewed regularly

It is important to ensure that both the will and the beneficiary nominations on an individual’s financial products are up to date to avoid assets and proceeds being paid to the individual’s estate instead of the intended beneficiaries.

Many other aspects of a comprehensive estate plan have been omitted, such as the use of discretionary unit trust investments during an individual’s lifetime, trusts, retirement and disability planning and offshore planning. Creating an estate plan can involve a high degree of complexity, and it is recommended that professional advice be sought before making any long-term decisions.