Tuesday, 24 April 2012 - 20:00

 

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Retirement Annuities as an Estate Planning Tool

Whilst most people see Retirement Annuities (RA’s) as a vehicle to fund provision of capital for their old age, this isn’t always the case as I was recently shown an example by one of my colleagues whereby changes in the rules relating to RA’s have given certain individuals an opportunity to plan their estates a lot more effectively.

Previously, members of an RA were compelled to retire from that fund before the age of 70. This rule has now fallen away and it is now possible to join an RA after the age of 70 with no mandatory retirement age; you may ask yourself “Why on earth would anyone in retirement want to purchase an RA?” But the following example will illustrate its effectiveness as a retirement planning tool for certain individuals:

“Mr A is 80 years old and has more than enough income and capital to fund his lifestyle. He has R 3 000 000 invested in a Money Market account at a bank which he decides to invest into an RA. For ease of calculation, we will assume that none of the R 3 000 000 is allowed as a deduction in the tax year of contribution. We will also assume that the underlying portfolio in the RA is a Money Market Fund earning the same rate as what he would have earned outside the RA. Mr A dies and the growth of the RA at this point is R 300 000 (which is the same as if he had left it in the Money Market account).

“If he hadn’t used the RA, Mr A would have had to pay R 120 000 in income tax (40% on the R 300 000 income from the Money Market account) leaving a net payout of R 3 180 000. The Money Market Fund would also be an asset in Mr A’s Estate, and if we assume that his estate duty rebate has been used on other assets, estate duty of R 636 000 would be payable. Executors fees of R 126 882 would also be payable on this asset leaving a net (after income tax, estate duty, and executors fees) R 2 417 118.

“By investing into the RA the interest earned is not taxed, leaving a total value of R 3 300 000 (all growth in an RA is currently tax free). The RA is not an asset or a deemed asset in the estate and is dealt with as a taxable lump sum death benefit received from a Retirement Fund. All contributions made to a Retirement Fund, not previously allowed as a deduction, are allowed as a deduction when calculating the taxable portion of the death benefit. If we assume that Mr A has already used his R 315 000 tax free retirement benefit, then total tax of R 54 000 will need to be paid, leaving a net benefit after tax of R 3 246 000.”

One must bear in mind that by locking up capital in an RA, accessibility will be greatly reduced (only 1/3rd is available as a lump sum) so this is a tool which should only be used by individuals with a large amount of free capital which is not going to be used or required during their lifetime. Naturally this type of strategy doesn’t make sense for most investors, but for those that it does, the potential benefits should not be ignored.

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Kind regards,

Barry Hugo
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966

Tue, 24 Apr 2012

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