The government introduced beneficiary funds in 2009 to provide a safe vehicle to accept lump-sum death benefits allocated by retirement funds to the minor dependants of deceased fund members.
Your retirement fund death benefits are not paid into your estate; they are governed by section 37C of the Pension Funds Act, which requires the fund’s trustees to determine: who was dependent on the late member; each dependant’s level of dependence; an equitable split of the benefit; and the most appropriate method of payment.
The trustees have a duty to decide how to divide the benefit in the best interest of all the member’s dependants. They have three options when it comes to a minor child’s portion:
• Pay the amount as a lump sum to the child’s guardian, but this is not without problems (see below).
• Keep it in the retirement fund to be administered there. This is not ideal, because retirement funds are geared to the contribution phase of a person’s savings, not the draw-down phase, in which children have to be sustained and educated.
• Pay it into a beneficiary fund.
The advantage of a beneficiary fund is that the child’s financial interests are protected by the fund’s trustees, while the guardian is not left powerless, because he or she liaises with the fund about a monthly budget for the child.
Beneficiary funds invest a child’s money and make monthly payments (a stipend) to legal guardians and caregivers to help with the child’s general living costs. Larger amounts may be paid out separately for expenses such as school fees and medical costs.
Tax advantages
A beneficiary fund has the following tax advantages:
• Most lump-sum benefits paid out by retirement funds are less than R500 000, which means they can be transferred to a beneficiary fund tax-free;
• Any income or capital paid by the beneficiary fund is tax-free; and
• No tax is paid on termination of the fund when the child turns 18 and is entitled to receive the remaining proceeds. There is nothing to prevent an 18-year-old from leaving the funds in the beneficiary fund and continuing to benefit from the tax advantages.
Asset allocation
The main aim of a beneficiary fund is to look after a child’s financial interests until he or she turns 18 – that is, to ensure the child is sustained and educated until he or she can look after him- or herself.
As stated earlier, a beneficiary fund is geared to the draw-down phase of a person’s retirement savings. This affects the investment strategy of the fund, because it must provide a high degree of liquidity while investing for capital growth. The aim is to “stretch” the capital as far as possible so that the child is educated and, hopefully, still has some capital when he or she turns 18.
The asset allocation should be tailored for each child, taking into account his or her age, income requirements and the size of the benefit.
Paying directly to the guardian
If a child’s portion of the death benefit is paid directly to the surviving spouse or guardian, that money may be subject to income and other tax (unless it is less than the income tax threshold), whereas it is tax-free in a beneficiary fund.
Furthermore, there is no guarantee that the guardian will use the funds in the best interests of the child. She or he may decide, or be under pressure, to use the funds for a family expense, thus depriving the child of the best education possible.
A beneficiary fund account is in the child’s name, effectively ring-fencing the money. Capital payments must be requested by the child’s guardian or caregiver and approved by the trustees, ensuring that the funds are used in the best interests of the child.
A beneficiary fund is defined as a pension fund organisation in terms of the Pension Funds Act; therefore, it is subject to the same rigorous regime as retirement funds. In the event of a dispute, members (the minor children who have accounts) have recourse to the Pension Funds Adjudicator.
The administrators of beneficiary funds must be licensed by the Financial Services Board, and funds are overseen by a board of trustees.
It might be a worthwhile exercise to sit down with your spouse or partner, or the person you have appointed as your child’s guardian, and ask the following questions:
• Will the death benefit be used in the best interests of the child?
• Will the money be stretched as far as possible to ensure that the child receives the best education available?
• Can the money practically be ring-fenced if the guardian dies?
• Can the guardian access the expertise required to achieve the best returns, at a reasonable cost?
A beneficiary fund for your child’s education may take pressure off the surviving spouse or guardian.
Many parents cater in their wills for a testamentary (will) trust to be set up for their minor children in the event of their death. Such trusts are tailored to a family’s circumstances, with trustees appointed in advance. They are not cheap to administer. On average, a testamentary trust, with professional trustee input and investment manager fees, could cost upwards of R20 000 (excluding VAT) a year. Compare this with a beneficiary fund, where on a R500 000 death benefit due to an eight-year-old child, you will pay about 2.72 percent (excluding VAT) a year, which includes administration, governance and investment fees. This is quite a compelling proposition given that the fees on retail investment products can be as high as two percent a year.
What you need to do
If you believe that a beneficiary fund is best way to secure your minor children’s financial well-being, you should fill in or update your retirement benefits nomination form, requesting that the portions the fund’s trustees allocate to your minor children be paid into such a fund.
You should provide the trustees with as much information and guidance as possible. You could attach a “letter of wishes” to your nomination form, describing your family’s circumstances and naming the guardian.
• David Hurford is a director of Fairheads Benefit Services.