Illustration: Colin Daniel

This article was first published in the 1st quarter 2017 edition of Personal Finance magazine.

Taking out life assurance remains an effective strategy for generating a substantial amount of capital to provide for loved ones upon death, and it’s a must for anyone with debt, or anyone with limited capital and high expenses. The amount of life cover you have should be based on the amount of debt that will have to be paid off when you die and the needs of your dependants, but it should also cover possible taxes and fees.

There is often confusion over whether or not the proceeds of a life policy form part of a deceased person’s estate. The truth is that the proceeds do not form part of your estate if you nominate beneficiaries, but are deemed to be your property for the purpose of calculating estate duty, which is levied at 20 percent of the net value of your estate over and above the abatement of R3.5 million.

If your policy does not specify beneficiaries and you want the proceeds to be paid into your estate, executor’s fees of 3.5 percent (excluding VAT) and estate duty will apply. So if you are unwilling to pay higher premiums for the additional life cover you need to take care of taxes and fees when you die, there could be serious consequences for those you intend to provide for.

Life partners and policies

There are a couple of life policy issues that are worth discussion. Domestic life policies can be registered under antenuptial contacts or postnuptial contracts for the benefit of your spouse or a child. This means that the proceeds do not form part of your estate and no estate duty or executor’s fees apply. The same applies to lump-sum death payments that arise from pension or provident funds.

If you have a domestic life policy on your life with your spouse as sole beneficiary, the proceeds of the policy will be deemed to be property in your estate, but because all bequests to spouses are deductible, the net effect will be that estate duty will not apply. No executor’s fees will apply, because the proceeds will be transferred directly from the life assurer to your spouse without the executor’s involvement.

The definition of “spouse” for the purposes of estate duty is broad and includes same-sex and heterosexual couples who are not married but are in relationships that are intended to be permanent.

Marriages out of community of property with the accrual system are common, and this is a fair form of marriage that respects the varying amounts of assets brought into a marriage and the different roles partners play during a marriage. If you are married out of community of property with the accrual system and have nominated your estate as the beneficiary of a life policy, the proceeds will form part of the accrual calculation. If the accrual claim is in favour of the surviving spouse, the claim will be deducted from the gross estate and, as the net estate will be reduced, so will the estate duty.

If you have nominated third parties, including children, relatives or friends, as your beneficiaries, no executor’s fees will apply, but the proceeds will not be deductible, so estate duty will apply. Your executor will pay the duty but will recover the amount from your beneficiaries. If your beneficiary has paid the premiums towards the policy on your life, the amount included in your estate will be reduced by the total premiums paid, plus interest of six percent (the legally allowed rate), which lessens their burden.

If you would like to ensure that there is sufficient liquidity in your estate to pay off your debt and/or you would prefer certain assets to be inherited in their entirety, you could nominate your estate as the beneficiary of your life policy, and then both estate duty and executor’s fees will apply to your life proceeds.

However, if you are married in community of property, the situation is somewhat more complicated. If your estate is your nominated beneficiary, the proceeds form part of your joint estate. Half of the proceeds will be subject to estate duty, yet the executor may charge fees on the full value of the proceeds. If your spouse is the beneficiary of your policy, again the proceeds will be deductible and not subject to estate duty. When married in community of property with a third party as the beneficiary, half of the premiums will be considered to have been paid from the communal estate and the amount to be included for duty will be the full value of the policy proceeds, less half of the premiums paid, plus six-percent interest.

Non-domestic life policies

Lump-sum death benefits from group life policies that are not part of pension or provident funds are treated similarly. If your spouse is the beneficiary, the net effect for estate duty and executor’s fees is nil, but if your children, relatives or friends are beneficiaries, they will be liable for the estate duty that applies to their proceeds.

The pitfall with group life cover is often that the employer, rather than the employee, determines the amount of cover. Employees often end up being under-insured for the capital they need to cover debt, provide for those they would like to protect, and to pay estate duty and executor’s fees.

If you are the owner of a life policy on the life of another person, this will be considered to be an asset in your estate, and the surrender value will be deemed to be property in your estate. Executor’s fees will apply, as well as estate duty, and the duty will not be recoverable from the person whose life was insured.

Or you might be a partner in a business and have a buy-and-sell contract on your life, which will enable your partner to purchase your share of the business when you die. The policy benefits your partner and, if certain requirements are met, will not be included in your estate, so no estate duty or executor’s fees need to be considered. If you are a key person in a business, the business might take out insurance on your life to cover the loss the business would suffer if you died. This policy benefits the business and again, if certain requirements are met, the proceeds will not be included in your estate.

Don’t let costs undermine benefits

In summary, when you determine the amount of life assurance you require, it is essential to establish whether or not the proceeds will be subject to estate duty and executor’s fees, so you can make sure you have sufficient cover for the capital amount intended for beneficiaries, plus taxes and fees.

Circumstances change all the time. Personal debt fluctuates, mortgages decrease, living expenses increase and the gross premiums paid by third parties increase. It is important to review periodically the amount of cover you require and the associated costs that might accrue to your estate or beneficiaries.

Linda Graham has the Certified Financial Planner accreditation and the Postgraduate Diploma in Financial Planning from the University of the Free State.