A living annuity can have significant tax benefits for some individuals
By Elmie de Jager
A few weeks ago, my colleague wrote about annuities and where it fits into one’s planning. When it comes to living annuities, people think of it as being the darker side of retirement annuities, where you will be taxed on the income for which you have received a tax deduction all those years before.
Living annuities, however, have some very interesting tax benefits for people who, after retirement, find themselves with two problems, namely high income tax on interest earned and estate duty.
If you understand section 10C of the Income Tax Act, and how it can be applied to your specific situation, a living annuity can be a very valuable arrow in your quiver to guard against the various wealth taxes that have appeared in recent years.
To revisit the rules of the estate duty: All assets in your personal name (including loan accounts between yourself and your trust) are subject to estate duty, except for the following:
Upon the death of each spouse, an exemption of R3,5 million is applied, which means that upon the death of the surviving spouse there is a combined estate duty exemption of R7 million.
All assets in the deceased’s estate over and above the combined exemption (R7 million up to R30 million) are subject to 20% estate duty. Above R30 million, the rate increases to 25%.
What do I mean by “previously disallowed contributions”?
In any specific year, there is a limit on how much of your retirement saving contributions can be deducted for income tax purposes, but there is no limit on how much you may contribute. The absolute maximum permissible deduction is currently R350 000.
Any contributions over and above the maximum are known as disallowed contributions and these unused credits create a golden opportunity to improve the management of your tax affairs after retirement.
Let me explain the rules about section 10C using a practical example. See the accompanying table.
Assumptions: 8% growth, 100% of growth is in the form of interest income, current tax tables and exemptions are applied, the estate duty exemption of R3.5m per individual or R7m per couple has already been used, and the investor did not receive any other taxable income.
When you retire from a retirement annuity and start to withdraw an income from the living annuity, this income can be tax-free if, historically, your contributions to your retirement annuity were more than the maximum allowable contribution for tax purposes according to legislation at the time.
This concession in the Income Tax Act provides a great opportunity to significantly reduce your taxable estate after retirement while also earning a tax-free income, if appropriate for your financial plan.
The example shows a wealthy individual who has no need or appetite for risk and who invests R10 million in income funds from which he/she receives an income of R500 000 annually (which increases with 5% p.a). For the purpose of the exercise we assume an 8% annual growth rate on the investment.
Note the dramatically different outcomes after a period of 10 years:
If he dies at this stage, the taxable part of the initial R10 million investment will now be limited to only R3,7 million – what remains of the previously disallowed contributions.
In the case of a unit trust or fixed deposit in the client’s own name, the estate duty would be calculated on the balance of R9 674 348 instead of R3 711 054.
Points to note:
The balance (R7 802 146) will however be subject to retirement tax tables should the beneficiaries choose to withdraw the full amount.
In our opinion, the retirement tax would make it undesirable, in most cases, to withdraw more than the tax-exempt portion in cash. The balance will simply continue to provide an income to the beneficiaries, even though it is taxable.
In conclusion: The above scenario illustrates once again the possible financial implications of decisions that are made, often without proper consideration.
Before you make any important decisions, make sure that you consult a professional adviser who will take your specific circumstances into account and consider the suitability of a solution to your financial plan.
Elmie de Jager is a certified financial planner at ProVérte Wealth & Risk Management. Email her at email@example.com.
Although all possible care was taken in the drafting of this document, the factual correctness of the information contained herein cannot be guaranteed. This document does not constitute advice and anyone planning on taking any financial action based on this document, is strongly advised to first consult with their personal financial advisor. ProVérte Wealth & Risk Management is an authorised financial service provider with FSP no. 5966.
True to company culture, Samuel strives to build solid long term relationships with clients and has a meticulous way of identifying needs, defining goals and compiling an executable plan to reach one's goals. He firmly believes that one has to be a specialist in one's field to be able to add value, and continuous training & education is therefore paramount. To be objective and to have an independent approach to a client's planning is critical to make a difference.
Born & bred on a farm in the Montague region, Samuel matriculated in 2001 from Montague High School. He completed his BComm Honours degree in Business Management as well as his Postgraduate & Advanced Diploma in Financial Planning. Samuel is a CFP charter holder. Apart from a short stint at an agricultural company Samuel has spent his whole working career with ProVérte. Samuel is a shareholder and valuable member of the board of directors of ProVérte.