HARRY JOFFE: How to inherit retirement fund benefits tax efficiently
Let's look at the different scenarios and options
Dependants of retirement funds and/or beneficiaries of living annuities have a very difficult decision to make when the member or annuitant dies. Do they take a lump sum, an annuity, or a combination? The wrong decision can have serious tax consequences.
Let's look at the different scenarios and options.
Scenario 1: Death of a member in a retirement fund
Mr A dies as a member of a retirement annuity (RA) with a fund value of R1m. He has three dependants (remember that the trustees of the fund have the power to determine who are dependants, and this overrules any beneficiary nominations). What are their choices, and what are the tax consequences?
Option 1: Take the lump sum
If the dependants decide to take the lump sum, the tax is payable in Mr A's deceased estate. This tax is calculated using the retirement fund lump-sum tax tables.
That means that if Mr A had not yet retired and therefore not used up his tax-free amounts, the deceased estate would qualify for these.
In terms of the retirement tables, the first R0-R500,000 of any lump sum is tax free, from R500,001-R700,000 is taxed at 18%, from R700,001-R1,050,000 is taxed at 27%, and only a lump sum of over R1,050,000 is taxed at 36%. Note that these concessions are only available once over a lifetime.
That means that in this case and assuming Mr A had not previously retired or used the concessions, it would make sense for the dependants to take the lump sum.
Option 2: They take an annuity.
If the dependants decide to take an annuity, they will pay the tax on the monthly annuity at their marginal rates, as the tax concessions on the lump sum table fall away.
The dependants do have a third option: a combination of the two. To the extent they take a lump sum, it will be taxed as per Option 1, and to the extent they draw an annuity it will be taxed as per Option 2.
When a member dies while still in a retirement fund, there is a good chance they have not used their lump sum retirement concessions.
The dependants should make sure to take at least a part of their payout as a lump sum, to make use of the retirement concessions. If the lump sum is very large, they should consider taking only a part as a lump sum and the balance as an annuity, as any lump sum taken above R1,050,000 will be taxed at 36% on the tables.
Dependants should seek professional advice before deciding based on the facts of their case.
However, they should consider taking a lump sum (or part thereof) to the extent that any lump sum retirement concessions are still available. In addition, even if the lump sum they draw will be partly taxed at 36%, this may still be lower than the marginal rate of the dependants, and the rate they will therefore pay on any annuity they draw.
Scenario 2: Death of a member in a living annuity
Mr A dies as a member of a living annuity. He has three beneficiaries, who are, unlike in a retirement fund, binding and the fund value is R1m. What are their choices, and what are the tax consequences?
The tax consequences are the same as for the retirement annuity. However, seeing as Mr A has already retired, it can be assumed that he has drawn a lump sum, and the tax-free concessions are no longer available. This means that the beneficiaries should consider drawing an annuity. However, things are not that simple.
First, Mr A might not have used up his entire tax-free or lower tax concessions on the lump sum tables. There might be some available to utilise by drawing a lump sum. Second, if the beneficiaries are already at the top marginal rate of 45%, any annuity they draw will be taxed at 45%. It might then be better for them to draw a lump sum, even at a tax rate of 36%, and have full use of the money.
Note that if Mr A had made any tax deductions contributions to his fund that exceeded the deductions allowed, on his death these can only be set off against any lump sum taken, and thereby increase the amount of the lump sum that is tax-free. The nondeductible contributions cannot be used against any annuity drawn by the dependants/beneficiaries.
Dependants or beneficiaries of retirement funds, RAs or living annuities should make decisions only after seeking professional advice that includes checking all the details of the deceased's affairs to ascertain any available tax concessions.
• Joffe is head of legal services at Discovery Life