How to use living annuities and RAs as wealth transfer tools

Question

I have R15-million saved in a retirement annuity (RA). As I have sufficient income from other sources, I will not need these funds to provide me with a pension. I would like to leave the full R15-million to my son, who is about to start university. How do I do this, and how can my son avoid paying estate duty?

Answer

You can nominate your son as the beneficiary of the RA. However, this will not guarantee that the full R15-million will be paid to him when you pass away and the funds are still in the RA. This is because retirement annuities are governed by the Pension Funds Act, so the trustees of the RA fund must do a full check to see that there are no other deserving claimants on these funds. This can result in delays in the transfer of the funds and the danger that your son may not get the full R15-million.

There are ways around this. The solution we choose will depend on your age.

If you are under 55

If you are under 55, you cannot mature your RA, so if you die, the trustees will have the ultimate say in what your son inherits.

What I would recommend in this instance is that you draft a note that expresses your wishes that your son should inherit the RA. If there are other dependants and potential claimants, you can mention how they would be taken care of in the event of your death.

You can give this to your financial adviser, who could pass it on to the trustees of the RA fund. It is not a foolproof solution, but it can go some way towards ensuring that your wishes are taken care of.

If you are over 55

If you are over 55, I would recommend that you convert your RA into a living annuity and make your son the beneficiary. When you pass away, the proceeds of the living annuity will be transferred immediately to your son.

With a living annuity, you are obliged to take a drawdown of at least 2.5%. I would recommend that you reinvest this money immediately into another RA. This will ensure that you do not pay any tax on the income. You should make your son the beneficiary of the second RA, so he won’t be losing any value.

When investing in a living annuity, you will have access to the full range of investment portfolios. You will not be impacted by any regulations that govern where you can or can’t invest your money.

The capital in the annuity will grow in a tax-free environment – there is no capital gains tax, no dividends tax and no income tax in the structure. It is a clean and efficient way to grow capital for the next generation.

When you pass away, your son can choose how he wants to receive the benefit:

He can take a lump sum. However, this will trigger the retirement lump-sum tax, which becomes expensive at higher amounts.

The better option is to transfer it into a living annuity in his own name. Here the capital enters his hands tax-free and he only pays income tax on the drawdown he selects. If he took a drawdown of 4% on the R15-million, he would receive a monthly income of about R50,000. He would have the ability to decrease or increase the drawdown percentage depending on his personal circumstances.

Estate duty

Estate duty will be impacted by how the RA was funded.

Allowed contributions: If the RA was purchased by taking advantage of your annual retirement allowance of 27.5% of your taxable income, then all the proceeds would fall outside your estate.

No estate duty would be payable at all, regardless of whether your son chose to receive the benefit as a lump sum or as an annuity. This is one of the few areas of estate planning where the legislation deliberately creates a tax-efficient intergenerational wealth transfer tool.

Disallowed contributions: If the RA was purchased using funds that did not qualify for the 27.5% retirement allowance, it would be classed as a disallowed retirement contribution.

As long as your son elected to receive the proceeds of the investment as an annuity, no estate duty would be payable. If, however, he elected to receive the benefits as a lump sum, estate duty of at least 20% would be triggered.

RAs and living annuities are great tools for transferring wealth efficiently – the key is setting them up correctly. A bit of planning now will ensure that your son receives the full benefit of what you’ve built. 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@sfpwealth.co.za

This story first appeared in our weekly Daily Maverick 168 newspaper, which is available countrywide for R35.