RAs remain ‘a great estate-planning tool’

Retirement annuities ( RAs) will remain a great estate-planning tool even once restrictions on the taxdeductibility of contributions are implemented, Jenny Gordon, the head of retail legal support at Alexander Forbes, says.

Some of the provisions in the Taxation Laws Amendment Bill, which is before Parliament, are designed to clamp down on wealthy people who over-contribute to retirement funds in order to reduce their income tax and estate duty.

You can claim a tax deduction of up to 7.5 percent of your pensionable income on annual contributions to an occupational retirement fund and up to 15 percent of your taxable income, less your pensionable income, on contributions to an RA fund.

Some wealthy people contribute more to an RA than the maximum deductible contribution of 15 percent of non- retirement- funding income. Although the excess amounts are not tax-deductible, they earn investment returns that are not subject to tax, and they can pass on the money in the RA to their beneficiaries free of estate duty.

The amendment bill states that any retirement fund contribution made from March 1 next year that does not qualify for a tax deduction will be included in the estate, for estate duty purposes, of people who die on or after January 1 next year.

Gordon says the amendment does not apply to contributions that qualify for a tax deduction under the current tax regime or the new regime that is scheduled to take effect on March 1, 2016.

Under the new regime, 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, when you can claim them if you do not use your full tax deduction in that year.

Gordon says the restriction on the estate duty exemption for RA contributions applies to so-called “death bed” lump- sum contributions made with after-tax money.

On 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, an amount between R500 001 and R700 000 is taxed at 18 percent, an amount between R700 001 and R1 050 000 is taxed at 27 percent, and any amount over R1 050 001 is taxed at 36 percent.

Gordon says there are many reasons to use RAs as an estateplanning 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 twothirds 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, Gordon says.

On the 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.

There is no estate duty on savings in an RA, unless the deceased made contributions that did not qualify for a tax deduction, and the savings are not subject to capital gains tax.

◆ 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 aftertax contributions.

So, 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, Gordon says.

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.