Retirement annuities (RAs) will remain a great estate-planning tool despite new restrictions on contributions. Currently, annual contributions to a retirement fund will be tax-deductible up to 27.5 percent of the higher of your remuneration or taxable income, but with a cap of R350 000 a year. Contributions that do not qualify for a tax deduction can be rolled over to a following year and can be claimed if you do not use your full tax deduction in that year.
Upon your death, your beneficiaries can take the full benefit (amount saved in the RA) as a lump sum or an annuity (income or pension).
If the benefit is taken as an annuity, the income is taxed at the recipient’s marginal rate of income tax. If the benefit is taken as a lump sum, the amount is deemed to have accrued to the deceased fund member on the day before his or her death, and it is taxed in the hands of the deceased as if the member had retired from the fund. As a result, the first R500 000 is tax-free.
There are many reasons to use RAs as an estate-planning tool. These include:
- Savings in an RA do not form part of your estate if you are declared insolvent and they are largely protected from your creditors, because there are only limited circumstances in which deductions can be made from your RA savings.
- Most small business owners consider their business to be their retirement plan without considering the risks of placing all their eggs in one precarious basket. Over-funding an RA might be a good long-term retirement strategy.
- You must use at least two-thirds of the benefits of an RA to buy either a living annuity or a guaranteed annuity. An advantage of a living annuity over other income-producing investments is that the investment growth is not subject to tax; tax is payable only on the income. Retirees who want to buy, or top up, a living annuity must first inject the capital into an RA fund.
- Upon a pensioner’s death, a beneficiary has the choice of taking any residual capital in the living annuity in cash or buying an annuity, or a combination of both. If an annuity is purchased, the beneficiary will pay tax only on the annuity payments.
- Income from a pension is included in your taxable income, against which you can claim a tax deduction for contributions to an RA. In addition, you can claim a refund of the tax paid on the income from a compulsory annuity to the extent of your after-tax contributions.
Therefore an after-tax lump sum injected into an RA has tax benefits for a person who is drawing an income from a living annuity or who wants to top up a living annuity, If the lump-sum injections are fully deducted, or if the tax on the compulsory annuity income has been fully refunded by the time the person dies, there will be no estate duty on the lump sum. On the other hand, if you put the lump sum in a discretionary investment, it could be liable for estate duty, depending on whether the assets in the estate that attract estate duty exceed the estate duty exemption.