Weighing who gets your life insurance — your spouse or a trust
● One of the simplest yet ultimately most complex decisions you face when you take out life insurance is who to nominate as a beneficiary on your policy. In practice the decision is often taken with very little thought, with everyone just wanting to get the “policy on the books”.
Here are some things to consider when nominating a beneficiary of your policy.
Nominating your spouse as beneficiary
The advantage of nominating your spouse as the beneficiary of your life policy is the estate duty benefit.
In terms of paragraph 4(q) of the Estate Duty Act, when calculating estate duty payable by your estate, the executor can deduct “so much of the value of any property included in the estate . . . as accrues to the surviving spouse of the deceased”.
Your spouse is then defined in the Estate Duty Act as including a person who at the time of your death was your partner:
In a marriage or customary union recognised in terms of South African law;
In a union recognised as a marriage in accordance with the tenets of any religion; or
In a same-sex or heterosexual union which the commissioner of the South African Revenue Service is satisfied is intended to be permanent.
The definition of a spouse is therefore extremely broad, and most relationships where a couple simply live together will qualify, as long as it can be proved to SARS, on the facts, that the relationship was permanent.
If your spouse is the beneficiary, the proceeds of a policy paid out on your death will be deemed an asset in your estate for estate duty purposes, but will then also qualify as a deduction, and there will therefore be no estate duty payable on the proceeds.
However, there are a few disadvantages to nominating your spouse as a beneficiary:
The full proceeds of the policy will be paid into your spouse’s bank account. You need to decide if your spouse can handle such a large amount of money. Will your spouse know how to invest the proceeds, and be able to fend off the “vultures” that will circle trying to get their hands on the money?;
The proceeds will be an asset in your spouse’s hands, so even though there will be no estate duty payable on your death, there may be duty payable when your surviving spouse dies; and
The Davis tax committee, in its second report on trusts and estate duty, has recommended that the deduction allowed in paragraph 4q of the act be scrapped in favour of a much larger rebate for the deceased estate on death. However, there is no guarantee that this proposal will be accepted by the minister of finance.
Nominating a trust as beneficiary
If you nominate an inter vivos trust — a trust created while the founder is still alive — as the beneficiary of your policy, the main disadvantage is that your estate will normally not qualify for the deduction provided in paragraph 4q of the act, and the policy proceeds will be subject to estate duty in your estate after your death.
However, leaving the proceeds of the policy to a trust has the following advantages:
The policy proceeds will not be paid to the surviving spouse personally, but will be protected in the hands of the trust;
Although the proceeds will be subject to estate duty, the Estate Duty Act provides that as long as the trust is the owner of the policy, has paid all the premiums and is the beneficiary of the proceeds, an amount equal to the premiums paid, compounded at 6% per year, will be exempt from estate duty.
This can add up to a large exemption if the premiums are paid over a long period of time; and
Having a trust as a beneficiary avoids the problems that arise if both spouses die simultaneously.
If you do not have a spouse, then there is no debate, as there is no deduction in terms of paragraph 4q of the act.
An inter vivos trust should be set up to own the policy, pay the premiums and receive the proceeds.
At least then the proceeds will be protected, and there will be the partial estate duty exemption.
Deciding who to nominate as the beneficiary of the proceeds of your life policy is a very difficult decision.
Nominating your spouse has estate duty benefits, but does not protect the money.
Nominating an inter vivos trust protects the money, but has much more limited estate duty benefits.
You should seriously consider both options and have a detailed discussion with your financial adviser.
In this article I have considered the limited scenario of whether it is better to nominate a spouse or trust as the beneficiary. There are many occasions when it would make sense to nominate someone other than your spouse or a trust — for example, an adult child, or even your estate if you need to ensure there is enough cash in your estate to pay off all your debts, costs and taxes.
There is no one-size-fits-all approach. Do not take the quick or easy way out believing that you can always fix the problem later, as no one knows when they are going to die.