Amendments to the Estate Duty Act will be proposed later this year to prevent you from making large lump-sum contributions late in life to a retirement fund in order to avoid estate duty.
Since the Estate Duty Act was amended in 2008, the proceeds from your retirement fund or living annuity have been exempt from estate duty after you die.
In that same year, the Pension Funds Act was amended to remove the age limit, then 70 years, after which you could not contribute to a retirement annuity fund (RA) and had to purchase a pension.
This, together with the fact that the retirement fund contributions you cannot deduct in any tax year can be taken tax-free on death or retirement, has led to RA contributions being used as an estate planning technique to pass assets on to beneficiaries free of estate duty.
Soré Cloete, senior legal adviser at Old Mutual, says the technique has been used widely and some people have even invested in RAs only to retire immediately from them – a practice dubbed “the one-day RA”.
She says Old Mutual warned advisers and consumers using the practice that it could potentially be regarded as a tax-evasion scheme.
Cloete says if you are likely to have an estate that is greater than the current estate duty exemptions, it is better to start estate planning early in life so you can limit the growth of your dutiable estate.
The Budget Review states that, to eliminate the potential of avoiding estate duty, the government will propose that contributions to a retirement fund not deductible for tax purposes be included in your dutiable estate when you, as a member of a retirement fund, die.
In addition, it plans to introduce a maximum age by which you must retire from a fund.
Tax deductions for contributions to an RA, pension fund or provident fund are expected to change on March 1 next year.
If the change, currently provided for in the Income Tax Act, goes ahead as planned, you will be able to deduct 27.5 percent of the greater of your taxable income or remuneration up to a maximum of R350 000 in any tax year.
This means that, currently, you could contribute a large sum of, say, R1 million to an RA at age 80, and the full amount plus any growth would be free of estate duty, regardless of how soon thereafter you died.
The proposed Estate Duty Act amendment will seek to limit the amount that is free of estate duty to what you contribute to the RA and have been able to deduct from tax before you die.
So, if your taxable income is R25 000 a month (R300 000 a year), you contribute R1 million at age 80 and die two years later, the amount that will be free of estate duty, under the new tax deductions that come into effect next year, will be calculated as follows:
R300 000 x 27.5 percent = R82 500
R82 500 x 2 = R165 000
Only R165 000 will be free of estate duty instead of the full R1 million.
Ronald King, a director at PSG Wealth Financial Planning, says the announcement is a bit of a shock, and it will be important to see the wording of the amendment before advising anyone who has made use of this estate planning technique on what to do.
He says that, in addition to the estate duty savings, there are other benefits to contributing to an RA: tax-free growth and the saving on executors’ fees. These have to be weighed up against your loss of liquidity when you invest in an RA.
The Budget Review also states that amendments to the Income Tax Act will be proposed this year to address anomalies that arise on death. On death you are deemed to have disposed of your assets, potentially giving rise to taxable capital gains, while income-producing assets are treated as income in your estate or in the hands of your heirs. Franz Tomask, general manager for legislative policy at the South African Revenue Service, says anomalies arise when a taxpayer holds shares that he or she is trading.