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I am an 80-year-old widow and have a R5-million investment that will mature soon. This provides me with an income of R33,000 a month, on which I pay R5,000 in tax. Since I also own a property, I am concerned that when I pass away, this investment will result in R1-million being paid in estate duty by my children.
How can I invest the money in order to pay the least amount of estate duty?
Answer
The situation is a little worse than you mentioned. In addition to the R1-million in estate duty, the investment will also result in more than 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 will 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 adviser to ensure that it is structured correctly to make certain that you get all the benefits.
There are three legal principles that I will be using 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 (RA), 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 you draw from a 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 R5-million to buy an RA, which you would mature immediately and use the proceeds to set up a living annuity. This is sometimes referred to as a “one-day RA”.
Any contribution to an RA that is above 27.5% of your taxable income will be classed as a disallowed contribution. The income 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 reduce what 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 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 estate to be finalised. In addition, as the executor will not be handling these funds, there will be a saving of about R200,000 in executor fees.
When you pass away, your beneficiaries will have two options for how to receive the proceeds of this living annuity:
If they take it as a lump sum, there will 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, no estate duty will be payable, but the income they take will be taxed at their rates.
The annuity 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.
Insider tip
Consider leaving some of the living annuity to your grandchildren. Since they are probably not taxpayers, the bulk of the annuity will not trigger any income tax in their hands.
There are a couple of smaller items that your planner would need to attend to, to ensure 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. DM
Kenny Meiring is an independent financial adviser. Contact him on 082 856 0348 or at financialwellnesscoach.co.za. Send your questions to kenny.meiring@sfpadvice.co.za.
This story first appeared in our weekly Daily Maverick 168 newspaper, which is available countrywide for R35.
