ENDOWMENT POLICY TRADES

I read about people who want to cash in their investment policies, such as retirement annuities (RAs) and endowment policies, but, for legal reasons, they cannot. Would it be possible for me to “buy” these policies for an agreed amount and substitute my name for that of the current policyholder’s and keep the policies until they mature, or trade them?

Neil McCafferty

Braam Fouche, a financial adviser at PSG Wealth in Umhlanga Rocks, Durban, responds: As a result of restrictions in the Income Tax Act and Pension Funds Act, RAs cannot be transferred, sold or ceded. These restrictions also apply to other retirement funds. A person who contributes to an RA receives various tax benefits, some of which are recouped when the RA is accessed, mostly on retirement. If transfers were permitted, the amount of tax recovered could be reduced if the person who took transfer of the RA was in a position to pay less tax on the proceeds. 

There are no restrictions on the transfer of endowment policies, and there used to be a large market in second-hand (traded) endowment policies. However, the appetite for these policies diminished after capital gains tax (CGT) was introduced. 

Let me explain: endowment policies offer specific financial planning and tax benefits, particularly to high-income earners, because endowment policies are taxed internally at a rate that may be lower than the tax rate the individual is paying. In the case of individual policyholders, income tax is withheld and paid by the administrator at a rate of 30% and CGT at a rate of 12%. Individuals in a higher tax bracket benefit from the lower tax rate within the policy, which enhances the after-tax returns on the investment. 

An endowment policy is designed to pay out the after-tax proceeds to the beneficial owner after a certain period, usually five years, so an investor who buys an endowment policy from another person or entity can derive the benefits without having to wait the full five years.

In terms of the Income Tax Act, the proceeds from insurance policies, including endowment policies, can be ignored for CGT purposes, but this exemption does not apply to traded (second-hand) endowment policies. With these policies, the after-tax proceeds will be taxed again in the hands of the subsequent owner, thereby defeating the objective of using such policies to reduce the tax on the investments. 

The Financial Services Board has warned the public to be wary when dealing in endowment policies, because these transactions are not regulated by the Long Term Insurance Act, and investors may not have any recourse via the Act if complications arise. 

There are instances where trading an endowment policy can be a viable option. However, you need to consider the possible pitfalls, such as additional costs, commission, cessions and outstanding loans on the policy. I recommend that you first obtain advice from a financial adviser. 


WHAT IS MEANT BY 'WEAR AND TEAR'

My homeowner’s insurance policy states that I am not covered for “wear and tear”. What does this mean – in other words, what are my responsibilities with regard to maintaining my property so that I will continue be covered?

Name withheld

Dieter Prinsloo, principal at PSG Insure in Durbanville, responds: Wear and tear is damage that results from normal wear or ageing. It is often referred to as gradual deterioration over time. A typical example is corrugated roof sheets that rust if they are not properly maintained, or waterproofing that becomes brittle and does not prevent water from seeping onto a concrete roof. 

The general terms and conditions of all policies usually include a “duty of care” condition, which stipulates that the insured must take all reasonable precautions to prevent or minimise loss or damage to the property.

It is usually clear how damage originated, and even if you are able to prove that you were not aware that wear and tear was taking place, the claim will be rejected, because wear and tear is normally a specific exclusion. It is therefore important that the entire property is maintained and that the roof is properly inspected regularly, to avoid disputes at claims stage.

The same can be said about appliances. If, for example, your stove is not in good working order because of normal use and ageing, it will not be covered. We recently dealt with a claim where an oven door did not close properly. The client submitted a claim for the stove and a damaged countertop above the stove. The claim was rejected, because the door did not close properly because of wear and tear. 

Bear in mind that a homeowner’s policy is generally intended to insure against sudden and unforeseen events, whereas wear and tear can be detected. 


IMPACT OF BRITISH AND AMERICAN DEATH TAXES

What are the implications for South African residents of death taxes on investments in the United Kingdom and United States, and how do they affect a surviving spouse? 

Name withheld

Graham Lovely, a financial adviser at PSG Wealth Rondebosch, Cape Town, responds: We need to understand the position in South Africa before we discuss the impact of death taxes on investments in the US and UK. At death, South African residents are taxed on their worldwide assets, and estate duty is levied at a rate of 20% on their dutiable estate.

In the UK, the exemption below which no inheritance tax (IHT) is payable is £325 000. This is referred to as a nil-rate band. Any amount above this nil-rate band is subject to IHT at a rate of 40%. A surviving spouse may be able to use his or her predeceased spouse’s nil-rate band, increasing it to £650 000. 

In the US, if the estate of a non-resident alien (such as a South African resident) is larger than $60 000, estate tax of 40% is payable on the excess. The US does not offer the equivalent spouse’s exemption. 

If US shares pass to a lawful spouse, there is no spouse’s exemption, unless the surviving spouse is a US citizen.

Generally, where IHT or estate tax is levied on an offshore investment, South African estate duty would still apply. In calculating the estate duty, allowance is made for death taxes already paid in another jurisdiction – in terms of, for example, South African/UK and South African/US double-taxation agreements.

It’s important to understand that the UK and US treat death taxes on investments in shares or unit trusts slightly differently. 

Shares held by a South African resident in a company registered in the UK and listed on the London Stock Exchange are deemed to be UK assets and subject to IHT. An investment in a UK-authorised collective investment scheme or a share in a UK open-ended investment company is excluded from IHT if the investor is not domiciled in the UK.

If a South African investor owns shares in a US company, the US deems the shares to be US assets subject to estate tax. The same applies to US-domiciled collective investment schemes.

It is important to ask your financial adviser about the implications of an offshore investment for your planning needs and the options that could mitigate against the impact of inheritance taxes – for example, using an offshore investment wrapper (endowment) or offshore trust.


WON'T I EARN MORE FROM CASH?

For some time, the return earned by my investment portfolio seems to be less than what I could earn on cash invested in a bank fixed deposit. Should I withdraw my investments and move them into a fixed deposit to earn a guaranteed return? 

Name withheld

Alexi Coutsoudis, a financial adviser at PSG Wealth in Umhlanga Ridge, Durban, responds: It is easy to feel disheartened, but the most important thing to keep in mind is your investment goal. Although cash is generally a good investment for the short term, it can underperform inflation over the long term, whereas asset classes such as property and shares generally outperform inflation.

One could draw an analogy to the life cycle of a tree. Sometimes, it may seem as if a newly planted tree is not growing, but this doesn’t mean the tree should be uprooted and replaced with an evergreen shrub if you need a large tree in your garden. A shrub will only ever be a shrub, just like cash will only produce a fixed-interest yield based on the inflation rate. 

However, if you have patience and understand the different seasons (market cycles), one day the tree will provide shade and may even bear fruit. This takes time, because a tree cannot reach maturity in a year or two.

A healthy investment portfolio should be well diversified to withstand “seasonal” changes. Some plants do well in winter, but they won’t survive or thrive in summer. It is the same with a portfolio, and is why investing in only one asset class, such as cash, is not the solution if you want to grow your portfolio over the long term.