Provident fund members, particularly those in higher income groups, need to be careful about how they go about appointing fund beneficiaries in the event of death. The beneficiary could be in for a nasty surprise as the taxman takes a large slice of those retirement savings.
At the core of the problem is the effect on retirement funds of income tax and the latest increases in death duties.
If you die while still working, the decisions you make beforehand and the rules of your provident fund could see the taxman taking a significant slice of any lump-sum payment to your heirs. And if the recommendations of the Katz tax commission are accepted, your heirs may even be worse off.
At the moment, if you die while still working, the proceeds of your provident fund are taxed at the average rate for that tax year.
But if you die and you haven't left all the proceeds to your spouse, there is an additional 25 percent to pay in death duties (up from 15 percent a year ago) on the after tax amount assuming your existing assets exceed R1 million at which point death duties click in.
For example, if your estate received R2 million from a provident fund there would be the initial tax-free deduction of R120 000 leaving R1,88 million. If your average rate of tax was 25 percent your estate would then pay R470 000 in tax leaving R1,41 million. This amount (plus the R120 000) could in turn be subject to the 25 percent death duties (R382 500), depending on what avoiding action has been taken, leaving R1 147 500. A tax contribution of almost 50 percent!
If the Katz recommendations (third report) are ever implemented, in a worse case scenario, the initial tax would be levied on a sliding scale with 45 percent being paid on any amount over R750 000 (the starting amount is 15 percent for amounts up to R150 000).
Without going into all the calculations there would be income tax payable of R765 000, leaving R1 235 000. Death duties would knock off a further R308 750 leaving R926 250. A tax contribution of almost 54 percent. But Martin Kourie of Momentum Life and co-author of the book, Tax and Investments Easiguide 1996, said there are ways to cut back on the death duties and the tax.
Firstly, if you leave everything to a spouse there would be no death duties due. This would include the position where the money was to be placed in a trust but only if the spouse was the sole beneficiary of the trust.
The duty and income tax could also be reduced by beneficiaries taking the fund benefits as an annuity (monthly pension) but, Kourie said, the provident fund's rules would have to make this a specific condition. The beneficiary may be a major or a minor it does not matter.
The tax exemption would also apply to adult children taking two thirds of the inheritance as an annuity.