Your will may be signed but is your estate plan sorted? And specifically, have you recorded (or updated) your beneficiary nominations?
Estate planning is often left for “later” – possibly because many of us put off planning for what happens after we die, but also because deceased estates, taxation and estate duty are complex topics.
What does an effective estate plan do?
The right estate plan takes into account the provisions of your will and minimises the applicable taxes and other expenses so that you maximise the residual value of the estate for the benefit of your heirs.
As a financial strategy, estate planning is crucial and up-to-date beneficiary nominations are an important part of it.
What to consider when nominating beneficiaries
An important step when creating a successful estate plan involves understanding the impact on your beneficiaries by nominating them as such. Depending on the geographical location of your beneficiary, there may be additional taxes levied by the jurisdiction where your beneficiary resides, so electing beneficiaries requires thoughtful consideration.
Two benefits of beneficiary nominations (and one caveat)
Certain investment vehicles allow for a beneficiary nomination. The benefit of nominating specific beneficiaries is that the proceeds are paid directly to the beneficiaries (rather than into the estate). The benefit of this is twofold: it increases cashflow certainty by eliminating delays and saves on executor’s fees.
The caveat is this: even when the proceeds of policies go directly to the nominated beneficiaries, they may still be subject to estate duty as they are a deemed asset within your estate according to SARS.
Before nominating beneficiaries, it is important to ensure there is sufficient liquidity in your estate to meet the related estate duty liabilities.
Let’s take a look at each of the common investment vehicles for which you might nominate beneficiaries.
1. Nominating beneficiaries of your life contracts
Nominating beneficiaries for your life insurance contracts ensures the proceeds of those contracts are paid directly to those beneficiaries rather than being paid into your estate. This quickly secures bridging cashflow for the beneficiaries as well as saving on executor’s fees (which can be charged at a maximum of 3.5% plus VAT).
The proceeds of life policies, though not paid into your estate, may still be subject to estate duty as they are a deemed asset within your estate according to SARS.
2. Nominating beneficiaries of endowments
Once again, nominating beneficiaries for your endowment policies ensures the proceeds of those investments are paid directly to those beneficiaries rather than being paid into your estate, with the attendant advantages of quickly channelling funds to beneficiaries and reducing executor’s fees within the estate. This is particularly helpful in the case of offshore endowments because the distribution of assets to beneficiaries occurs outside of the (costly and time-consuming) probate process.
3. Nominating beneficiaries of your living annuity
A living annuity is an investment contract that is purchased at retirement using the proceeds of retirement funds. When you pass away, the investment value of your living annuity is transferred to your nominated beneficiaries. As the proceeds are not paid into your estate, there are no executor’s fees on the proceeds. In this case there is also no estate duty as the proceeds are not deemed to form part of your estate.
Nominated beneficiaries have two options:
- they can cash out the living annuity, and this amount will then be subject to tax based on retirement fund lump sums taken during the lifetime of the deceased, or
- they can elect to keep the living annuity, in which case between 2.5% and 17.5% must be drawn annually as income. This amount drawn as income will form part of the beneficiaries’ taxable income together with any other income they receive.
Certain administrators allow you to appoint secondary beneficiaries who will be paid if your primary beneficiary passes away with or before you. Providing for secondary beneficiaries can result in significant tax savings.
4. Nominating beneficiaries of your retirement fund
Retirement funds (these include retirement annuities, pension, provident and preservation contracts) work slightly differently. Nominating a beneficiary on your retirement fund is advisable, but it doesn’t guarantee the beneficiary will receive the proceeds.
Section 37C of the Pension Funds Act aims to protect families and states that the trustees of your retirement fund are obliged to ensure that your dependants receive your retirement savings should you pass away. The trustees are obliged to ensure that your retirement savings are fairly distributed to anyone who has a claim as a dependant, regardless of who you nominated as a beneficiary.
A dependant (as defined by the Pension Funds Act) is a person for whom the member is legally liable to provide maintenance, or a person financially dependent on the deceased member (for example, an elderly parent financially supported by their child), or a person who the member would become legally liable to maintain had the member not passed away.
By nominating beneficiaries, you give the trustees an indication of your wishes, but you can go a step further by writing a motivation letter that will help guide the trustees. The trustees will use factors such as age, relationship and degree of financial dependence to make their determination. If you outline these factors upfront and stipulate how much each person should receive, it is more likely the trustees will make a determination that reflects your wishes. If you have provided generously for a dependant by bequeathing other assets to them, mention this in your motivation letter and explain why they do not need to be provided for by the fund.
In a nutshell…
Estate planning is the process of preparing for the management and distribution of your assets and wealth after your death, to ensure that your loved ones are provided for and your final wishes are respected. This can be affected through a combination of your Will and strategic beneficiary nominations on your various investments. It’s important to think holistically about your beneficiary nominations to meet the cashflow requirements of both your beneficiaries and your estate. It’s also important to keep your beneficiary nominations updated depending on changes in your life circumstances.
Make a note to ask about the relevance of beneficiary nominations in your estate planning when you next meet with your CERTIFIED FINANCIAL PLANNER® professional.
By Jonathan Botha, CFP®