Notes on Estate and Financial Plans Meyer on Case Studies

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1 Page 1 of 32 Notes on Estate and Financial Plans Meyer on Case Studies First Edition Errol Gottfried Meyer B. Juris, Education Diploma, Higher Diploma in Education, LLB, Advance Certificate in Taxation, Certified Affiliate of Association of Unit Trusts, Post Graduate Diploma in Financial Planning. CFP, Admitted Advocate of the High Court of South Africa, Master Tax Practitioner (SA) 1

2 [2] Preface Students that enrol for the Post Graduate Diploma in Financial Planning are required to pass a Board examination to join the ranks of a Certified Financial Planner (CFP ). The Board examination requires a combination of theory and practical application. A student must have an excellent knowledge of various disciplines, such as income tax, capital gains tax, estate duty, wills, trust law, retirement planning, financial calculations, etc. The difficulty, and often the challenge, is to integrate all of the above in a practical sensible financial plan. For instance, the mere fact that a client has assets housed in a trust has an impact on his income tax, estate duty, the drafting of a will, etc. The problem is that knowledge, or research on a technical matter, is seldom available in a holistic manner. This makes the rendering of holistic advice very difficult. This publication takes into consideration the various risk profiles of clients to ensure that the practical aspects of compliance legislation applicable to financial planners are covered in a sensible, practical and easy to understand manner. The aim of this book is to integrate financial planning fundamentals in a case study format. Different case study scenarios will be dealt with, each of them focussing on a different financial planning discipline. For example, the first case study exercise will deal with the cash flows of a financial plan. The other case study examples will deal with a financial plan with a specific focus on business financial planning, trusts planning, etc. Any student that wishes to pass the Board examination will find the book of immense practical value. Practitioners who prepare financial plans for clients will find the book useful since many of the practical applications are discussed in detail. Calculations are in respect of tax laws applicable for the tax year of assessment ending 28 February 2013 and legislation up to 1 February Where applicable the tax rates and Budget speech 2013 recommendations are referred to and compared to the current position.

3 [3] Contents Case studies with explanations 1. Case study on cash flows including the accrual claim Page 5 2. Advanced case study on cash flows excluding the accrual claim Page Case study for spouses married in community of property Page Case study on basic financial planning and risk profiling Page Case study including an inter vivos trust Page Case study on business financial planning Page 164

4 [4] CHAPTER 1 Case Study 1 Outcomes of this exercise. This case study exercise is presented in a simplified manner and makes use of easy to follow calculations. The purpose of this exercise is to understand the cash flows of funds, the order in which the calculations are done and the presentation of the financial plan so that a client can make an informed decision. Where does one start with analysing the financial affairs of a client? It is obvious that various tax calculations must be done before a diversity of cash flows can be analysed. In the end, establishing the cash shortfalls in an estate and financial plan is an important consideration of the financial planning exercise. 1 Which calculations should be done first to prevent a planner from going back and forth, or compel him to do various calculations simultaneously? For instance, to calculate the estate duty deductions in an estate, the accrual claim should be calculated before any estate duty calculation. But then, if the deceased estate cannot satisfy the accrual claim in cash, it will have an impact on the capital gains tax calculation since assets must be transferred to the spouse, which in turn will have an impact on the capital gains tax payable by the deceased and thus estate duty payable by the deceased estate. Capital gains tax payable by a deceased qualifies as an estate duty deduction. Logic dictates that an estate duty calculation cannot be the starting point since the accrual calculation, capital gains tax payable at death and the income tax calculation must be done before any estate duty calculation. Only then can the apportionment of estate duty and the final liquidity of the deceased estate be calculated. Immaterial and non relevant facts are often provided by a client since clients are anxious that you must have a thorough understanding of the exceptionality of their particular circumstances. An experienced and astute financial planner will be able to consider the relevance of the information and guide the client to extract the relevant and material information needed. After all, it is the duty of the financial 1 The following definition may serve as a guideline for all financial planners. A financial planning solution will often propose products that create and/or protect wealth and the solution must demonstrate a causal link with the agreed risk profile of a client. Tax efficient products/solutions will increase the cash flow of a client, which ultimately makes the purchasing of the financial product more affordable! - Errol Gottfried Meyer Financial Planning Institute Sandton Convention 2011

5 [5] planner to determine the risk profile of the client and enter into a contractual relationship with the client. 2 It remains the duty of a skilled financial planner to guide and educate the client so that the correct information is used in a financial plan. 3 In any financial plan or case study exercise it is always important to consider the following: 1. Which facts are relevant. 2. The accuracy of the information. 3. The importance or weight to be attached to the information obtained. 4. Which assumptions are reasonable. 5. Which facts are relevant to the desired outcome of the exercise. 6. Which facts must not be taken into consideration. 7. The real need of the client, which is often not money related. 8. How does the financial planner satisfy such a need? 2 Section 8 of the General Code of Conduct FAIS Act. 3 Section 16 (1)(a) of the FAIS Act. a provider must at all times render financial services honestly, fairly, with due skill, care and diligence, and in the interests of clients and the integrity of the financial services industry. See also Johan Adriaan Steenkamp v Old Mutual Life Assurance Company (South Africa) Limited FOC 1343/05 FS, issued 13 March 2006, where due care, skill and diligence was absent when a broker failed to elicit enough information from a client and to convey such information to the underwriting company.

6 [6] The facts of the case. Eric and Belinda are married and have two children, Genalee and Dale. Personal particulars Ages: Eric - 50 years Belinda - 40 years Genalee - 15 years Dale - 10 years They are married out of community of property with the inclusion of the accrual system. They were married on 16 December 1992 when the consumer price index was 50 (assume). In terms of their ante-nuptial contract the value of Eric s estate at the date of marriage was R and that of Belinda R Assume that the consumer price index currently stands at 150. At the time of their marriage, both Eric and Belinda were still employed. They both resigned from employment and Eric is now a shareholder of a successful business, Toni s Pizza (Pty) Ltd. The business sells pizzas and Eric is employed by Toni s Pizza (Pty) Ltd. Their respective incomes and other benefits from employment are as follows: Income and other employment benefits Eric earns a salary of R per month. Belinda earns R per month as a secretary. Eric is member of Toni s Pizza (Pty) Ltd Provident Fund. The company contributes an amount equal to 10% of his salary to the fund. The fund was established five years ago and the current value of his interest in the provident fund is R The provident fund provides a death benefit of R on the life of Eric. Eric nominated his wife and children as equal beneficiaries of his provident fund benefits. His children are minors and he is aware that the board of the provident fund will view them as dependants for purposes of the Pension Funds Act. He

7 [7] requests that it must be assumed for purposes of the financial plan that the provident fund will make payment in equal shares to his wife and two children. In terms of the rules of the fund Eric will retire at the age of 60. Assume that the estimated value of his interest in the provident fund at date of his retirement date will be R Business interests Eric owns 40% of the shareholding in Toni s Pizza (Pty) Ltd. The other shareholders are his brother Eugene who owns 35%, and a friend Stephen who owns the remaining 25%. The company was recently valued to be R All the shareholders entered into a buy-and-sell agreement. In terms of the agreement the other shareholders will purchase Eric s shares in the company in the event of his death. Eric s life has been insured for R for this purpose. Eric s assets Asset Value Liability Base Cost Primary residence Shares in Toni s Pizza (Pty) Ltd Collective investment scheme Eric s life insurance Death claim value Policy 1 payable to his estate R Policy 2 payable to his spouse, Belinda R Policy 3 payable to his son Dale R Belinda s assets Plot in Hermanus R She has no liabilities.

8 [8] Concerns, goals and objectives Retirement needs At retirement Eric would like to receive an income which is the equivalent of R per annum in today s value. This income must increase annually with the inflation rate and must be payable for a period of 15 years after his retirement. The value of his interest in the business at the time of his retirement must not be taken into account as capital for retirement. He would like his children to inherit the proceeds. You are instructed by the client to only take the provident fund value into account for determining whether Eric has sufficient retirement capital. His wife and children Eric would like his wife to have sufficient capital in the event of his death to enable her to have an income of R per annum (in today s value) for the rest of her life. You must ignore any income she receives as a secretary. Assume that she has a life expectancy of 35 years. He wishes to ensure that in the event of his death each of his children will receive an income of R per year until their 21 st birthday (this is for periods of 6 and 11 years respectively). These annual income amounts must keep pace with inflation. Eric is confident that he has made adequate provision for his dependants, but he would like you to confirm that he is correct. Medical scheme Eric is a member of a medical scheme. His wife and children are also members. Eric contributes an amount of R2 320 per month to the medical scheme. Last Will and Testament In terms of Eric s current last will and testament he bequeaths an amount of R million cash to each of his children. This amount must be held in trust until the age of 21. He wants his children to inherit the above cash legacies in addition to the capital that is needed for their maintenance until the age 21.

9 [9] His will states that the collective investment scheme must be sold by his executor and that the residue of his estate is bequeathed to his spouse. In her will, Belinda bequeaths the residue of her estate to her husband, Eric. Their monthly income and expenditure Salary - Eric Salary - Belinda Bond instalment Life insurance premiums Household expenses The interest and dividends earned on the collective investment scheme units are not included in their monthly cash flow since it is automatically reinvested. The interest payable on these units is 0,5% per annum of the capital value and the dividend is 1% per annum. The above cash flow does not include their income tax liability. You must calculate the total income tax due. Assumptions and rates The following rates and assumptions are used: an inflation rate of 6% a growth rate of 9% in respect of growth investments, and a pre-tax interest rate of 7% in respect of any fixed-interest rate investment. Last expenses on death amounts to R and Master s fees R600. Notes..

10 [10] Proposed solution to Case Study There is no prescribed methodology that must be followed. It is submitted that the following order is used: Calculate the accrual claim. Calculate the tax on retirement fund lump sum benefits. Calculate the capital gains tax payable on death. Calculate the income tax payable on death. Calculate estate duty and the residue for purposes of the spouse s estate duty deduction. Calculate the cash flows of the estate and the amount each beneficiary will receive. In this instance the accrual claim, income tax on the lump sum benefits, the capital gains tax liability on death and the residue of the estate for the purposes of the Section 4(q) deduction of the Estate Duty Act are done first. The suggested order will assist you to follow a logical approach and ensure that earlier calculations need not be recalculated. Such a chronological order will minimize mistakes and ensure that the calculations are done in the shortest time span. From the facts it is quite certain that Eric has sufficient capital available to fulfil his wishes. However, the purpose of the exercise is to understand the calculation of cash flows. Once the correct methodology is understood, more advanced calculations can be done to understand how to deal with shortfalls and the mismatch of cash flows for the dependants of Eric. Notes..

11 [11] Calculate the accrual claim Assets of Eric - Assets of Belinda - Primary Residence Plot in Hermanus Shares in Toni's Pizza (Pty) Ltd Collective investment scheme Add Policy 1 payable to estate Total Total Less Liabilities Bond on Primary Residence Total Less Inherited assets - Total Less Adjusted initial value Accrual Accrual claim Notes on the accrual claim If a marriage is entered into after 1 November 1984 the accrual system will automatically apply in respect of marriages out of community of property. On dissolution of the marriage the spouse with the smaller accrual will have a claim against the spouse with the larger accrual, for an amount equal to half the difference of the accruals. The accrual claim represents the net value of the estate at the time of the dissolution of the marriage less the net value of the estate at the commencement of the estate. The net value of the estate at commencement is adjusted with inflation in terms of the consumer price index so that inflationary gains are excluded. In this example Eric s commencement value is R To calculate the adjusted initial value R is multiplied with 150 and divided by The same applies to the adjusted commencement value of Belinda. 4 The actual CPI Index figures for the month of the conclusion of the marriage and when dissolved can be obtained from

12 [12] Section 4(lA) of the Estate Duty Act allows a deduction 5 of the accrual claim in the estate of the deceased for purposes of estate duty. 6 On the other hand a situation may occur where the deceased has an accrual claim against the surviving spouse in which event it will be included as deemed property in terms of section 3(3)(cA) of the Estate Duty Act. This may be problematic for the surviving spouse since the claim must be satisfied. Where the surviving spouse inherits the whole of the estate this does not present a problem. If assets are liquidated to pay the accrual, negative capital gains tax may arise. The accrual claim can be satisfied with assets and cash. Planning is necessary to determine how the accrual claim will be paid. Where a spouse dies after a divorce is finalised, but the accrual claim is not settled, then the deceased spouse has a claim against the surviving spouse and the accrual amount will not constitute deemed property, but property in terms of the Estate Duty Act. It cannot be said that the accrual system is similar to a marriage in community of property. The accrual claim is a personal claim that arises upon the dissolution of the marriage as opposed to a marriage in community of property where each spouse is entitled to a half undivided share of the joint estate. Therefore, inheritances received during the accrual marriage is excluded from the accrual, but not the inheritances received prior to the date of marriage. The reason is that the accrual is applicable to that which was accumulated during the marriage which the spouses have built up during the marriage. The same reasoning does not apply to marriages in community of property, since the criteria is not what was built up during the subsistence of the marriage, but all assets are combined in one joint estate. This explains why non patrimonial damages and donations received during the marriage is excluded from the accrual calculation. Should expenses of the deceased estate also be allowed as a deduction from the accrual calculation? Estate duty, executors fees and capital gains tax 7 payable as a result of death are not taken into consideration for purposes of this illustration. 8 5 The accrual claim is not a debt due similar to section 4(b) of the Act and thus not subject to the restrictions that the spouse must be resident in South Africa, or that he claim must be discharged from property included in the estate for estate duty purposes. See Meyerowitz Meyerowitz on Administration of Estates and Their Taxation, 2010 Edition, para A spouse is defined in the Act and will include a partner under a registered civil union.

13 [13] It is may be argued that the liabilities did not exist at the time of the dissolution of the marriage. The rationale of the accrual system is to share in the fruits of the marriage equally. 9 Note that all domestic insurance policies payable to the estate are included in the accrual calculation. Insurance policies nominated to third parties are not included in the accrual since the acceptance of the benefits by the beneficiary concludes a contract between the insurance company and the beneficiary. The estate does not acquire a right in terms of which the value of the policy can be claimed. The beneficiary acquires the right from the terms of the insurance contract where the benefits are made payable to the beneficiary upon acceptance of the benefits. If the beneficiary does not accept the benefits, the proceeds of the policy will be included in the accrual calculation. The provident fund is not part of the accrual claim as well as assets in terms of which the deceased held a contingent right to assets housed in a trust. Both are not included in the accrual calculation. Where the deceased had a vested right to trust assets it will be included in the accrual calculation. Notes There are two schools of thought and some argue that capital gains tax should be taken into consideration when calculating the accrual claim. See an unreported judgement (case 8954/10) delivered on 10 December 2012, in the High Court of South Africa Western Cape where it was agreed by parties that the capital gains tax should be taken into account upon the sale of the property. In this case it was a realized amount. 8 The cost of capital gains tax may be material to the valuation agreed upon. To avoid delays it must be ensured that the values agreed upon is reasonable since SARS has an interest in the estate duty deduction which is dependent on the amount of the claim. 9 The valuation of assets creates problematic issues. Meyerowitz (supra), para states that where assets of a deceased estate are realised in the course of liquidation, the realized prices are taken into account and where the assets remain unrealized their fair or market value at the time of death must be taken. It is suggested by him that a practical approach is for the executor to consult and agree with the surviving spouse upon the net value of the two estates...

14 [14] Capital gains tax on Eric s death Assets of Eric Market Value Base Cost Excluded Rollover Gain/Loss Primary Residence Shares in Toni's Pizza (Pty) Ltd Collective investment scheme Policy 1 payable to estate Policy 2 payable to Belinda Policy 3 payable to Dale Provident Fund Death Value Total Less Gain 33.3% Notes on capital gains tax payable on death In terms of the Last Will and Testament the collective investment scheme must be sold by the executor. It is therefore a deemed disposal to the estate and subject to capital gains tax in the deceased estate. 10 When the executor sells the collective investment scheme the market value and the base cost will be very similar with the result that no capital gains tax is payable by the estate, unless the value of the collective investment scheme appreciated or depreciated during the time of winding up of the estate and the sale thereof by the executor. In any event it will not form 10 See Newsletter by Errol Gottfried Meyer on Deceased Estates and CGT - (Date of use: 21 January 2013.

15 [15] part of the residue of the estate that is bequeathed to the surviving spouse and therefore the roll over relief will not apply. The primary residence will form part of the residue of the estate and qualify for roll over relief, provided the primary residence is not sold. This will depend if there is sufficient liquidity in the estate so that the asset can qualify for roll over relief. In this case study the estate is liquid and the estate will qualify for roll over relief. All domestic policies are exempt from capital gains tax. The buy and sell policy are not included in the capital gains tax calculations since Eric is not the owner of the policy but merely the life assured. Estate duty includes all policies in the deceased estate as deemed property since Eric is the life assured. The same rule is not applicable to capital gains tax that deals with ownership and it is immaterial who the life assured is. Non domestic policies are included in the capital gains tax calculation and do not qualify for the capital gains tax exclusion. They are also included for estate duty since they constitute property and not deemed property. Where the deceased was immediately prior to his death competent to dispose of the asset for his own benefit or for the benefit of his estate, it will be deemed property. The shares in Toni s Pizza Pty Ltd may qualify for the small business exclusion provided all the requirements are met. For the purpose of the calculation the exclusion is ignored but should be noted in the recommendation of the financial planner. 11 Notes 11 One may only disregard so much of the capital gain on disposal of the shares that relates to active business assets of a small business. All liabilities are ignored. See SARS Comprehensive Guide, Issue 4, page 361 for examples. The exclusion for the 2012/13.. tax year is R Other requirements must also be met...

16 [16] Tax Calculation for Eric On death GROSS INCOME Salary CIS Dividends CIS Interest EXEMPTIONS Interest exemption Dividend exemption INCOME DEDUCTIONS - Provident Fund Contributions - Medical aid deduction - Taxable income Plus: Taxable Capital Gain Total Taxable Income Tax on R % TAX PER SCALE REBATES Primary - under Medical aid credit TAX PAYABLE While alive Taxable income Plus: Taxable Capital Gain - - Total Taxable Income Tax on R % TAX PER SCALE - REBATES - - Primary - under Medical aid credit TAX PAYABLE

17 [17] Notes on tax calculation Two calculations must be done. One calculation on death where capital gains tax is added to the taxable income and one calculation while Eric is alive for budgeting purposes. Note that the dividend and interest income are included in the tax calculation since it is an accrual for income tax purposes, although reinvested. South African dividends are fully exempt from income tax but subject to a 15% withholding dividend tax. The taxpayer qualifies for a medical credit that is deducted from taxable income and rank in the same order as other rebates. If medical expenditure is excessive, then it is possible to claim a deduction as well, which will be calculated prior to calculating taxable income. 12 Certain limitations apply and will be illustrated in more detail in later case studies. In this case study there are no excessive expenditure and no additional deduction for surplus medical expenditure. The amount of the medical scheme fees tax credit for the 2012/13 tax year is as follows: R230 per month in respect of benefits to the taxpayer (only member); R460 per month in respect of benefits to the taxpayer plus one member; R154 per month for any additional beneficiary exceeding the first two. The medical aid tax credit is thus calculated as (154 2) = R768 per month. It therefore amounts to R9 216 per annum. The amount of the medical scheme fees tax credit for the 2013/14 tax year is as follows: 13 R242 per month in respect of benefits to the taxpayer (only member); R484 per month in respect of benefits to the taxpayer plus one member; R162 per month for any additional beneficiary exceeding the first two. The medical aid tax credit is thus calculated as (162 2) = R808 per month. It therefore amounts to R9 696 per annum. The interest exemption for the 2013/14 tax year is R for individuals below 65 years and increased from R to R for individuals 65 years and over. A discussion document was published in September 2012 and government intends to 12 Taxable income is defined in the Income Tax Act as gross income less income. See the application of the definition in the tax calculation example above. 13 Budget speech 2013.

18 [18] proceed with the implementation of tax deferred savings and investment accounts. All returns accrued in these accounts and any withdrawals will be exempt from tax. It is proposed that these accounts will have an annual contribution limit of R and a lifetime limit of R , which will be regularly increased in line with inflation. The existing thresholds will not be adjusted for inflation for future years of assessment. 14 The rebates for the 2013/14tax years will be: 15 Primary R Secondary R6 750 Tertiary R2 250 For the purpose of the case study the 2012/13 tax rates are used. Tax on provident fund lump sum Death value of Provident Fund Less Tax R Amount above R After tax amount Notes on retirement tax A lump sum that becomes payable on the death of a member is deemed to have accrued to the member immediately prior to his death. The tax is paid by the deceased member and not the recipients of the lump sum benefit. It is important to calculate the after tax amount since these amounts must be taken into consideration to calculate the value of all lump sums that is received by the dependants of Eric. Although the amount is taxed in the hands of the deceased member, the tax can be recovered from the person who receives the benefit. 16 Therefore, the after tax amount is equally divided amongst the recipients of the lump sum, namely Belinda, Dale and Genalee (R / 3 = R ). The recovery of tax will not present a problem since tax is withheld by the employer in terms of a tax directive. Retirement benefits do not form part of the estate and can thus never be taken into account in the calculation of the residue of an estate. 14 Budget speech Budget speech See Botha et al Financial Planning Handbook 2013, page 937.

19 [19] Benefits are paid directly to dependants and therefore not subject to executor s fees. The trustees of the provident fund have a discretion to pay benefits to the dependants who are financially and legally dependant on the member prior to his death. 17 This will require that the financial planner makes an assumption who will receive the benefits. In this case study it was contractually agreed that an assumption will be made in respect of who will receive the benefits. From 1 January 2009 a planning problem is alleviated since retirement lump sum benefits are not included as deemed property for estate duty purpose. It now becomes irrelevant for purposes of the spouse s deduction which amount accrues to the surviving spouse. An incorrect assumption prior to 1 January 2009 could have led to a situation where more estate duty may be payable if benefits are not paid to a surviving spouse. Since 1 January 2009 these estate duty consequences are no longer relevant and planning can be done with more certainty. Calculation of residue Primary Residence Shares in Toni's Pizza (Pty) Ltd Collective investment scheme Policy 1 payable to estate Total Assets Less Asset Liabilities Estate Liabilities Total liabilities Less bequests to children Less Accrual Residue before estate duty Residue after estate duty To be calculated Notes on calculation of residue Note that the total assets taken into consideration is the same amount that is used for the accrual calculation as well as the amount that the executor s fees are calculated upon. This makes sense since the residue is calculated with reference to what is in the liquidation and distribution account. Therefore, retirement benefits and policies nominated to third parties are not included. 17 Section 37 C of the Pensions Fund Act.

20 [20] To calculate the residue the capital gains tax and income tax calculation must be known. The other estate expenses must also be included, such as executor s fees, last expenses and Master s fees. The residue is calculated before the estate duty calculation in order to determine the spouse s deduction. The surviving spouse will receive the actual amounts after estate duty is paid out of the residue of the estate. The residue calculation provides two important answers: 1. To calculate the value of the spouses deduction, 2. To calculate the actual inheritance of the spouse. It will only be possible to determine the actual assets the spouse will receive once a liquidity analyses for the estate is done. The estate liabilities are made up of the following: Master's fees 600 Last expenses Executor's fees Income Tax and CGT The total estate liabilities amount to R R % = R The executor s fees are The actual residue after the payment of estate duty can only be calculated once the estate duty is calculated and after all estate duty apportionments are done. Notes....

21 [21] Estate duty calculation Property Primary Residence Shares in Toni's Pizza (Pty) Ltd Collective investment scheme Deemed Property Policy 1 payable to estate Buy and Sell policy on the life of Eric - Policy 2 payable to Belinda Policy 3 payable to Dale Gross Estate Asset Liabilities Bond on Primary Residence Deductions to spouse Policy 2 payable to Belinda Accrual claim Residue before estate duty Estate Liabilities Master's fees 600 Last expenses Executor's fees Income tax and CGT Net estate A Dutiable Estate Estate duty payable Notes on estate duty calculation A reconciliation can easily be done to see if the estate duty is calculated correctly. No estate duty is payable on assets, liabilities and estate expenses that qualifies as a deduction for estate duty. Therefore all estate liabilities, other existing liabilities and the residue to the spouse will qualify as an estate duty deduction. Stated differently, the only assets that can attract estate duty is the policy payable to Dale and the cash bequests to the children. The calculation for estate duty can thus also be done as follows: Policy 3 payable to Dale R Cash bequest to children R Net estate R

22 [22] Section 4A R Dutiable estate R Estate duty payable R Notes.... Apportionment of estate duty.. Apportion estate duty Policy to Dale Estate Total estate duty Notes on apportionment The apportionment of estate duty is an important cash flow consideration. Estate duty is not always paid out of the residue of the deceased estate. Where estate duty is levied... on insurance policies payable to third parties, the recipient of such proceeds are liable for a portion of the actual estate duty payable. This is due to the

23 [23] estate duty fiction that the value of a policy is included in the deceased estate by reason of the fact that the deceased is the life assured and not necessary the owner of the life assurance. In this case study Dale is the recipient of Policy 3. The estate duty attributable to such a policy is calculated as follows: (R R ) R = R The estate is responsible for the balance of R which reduces the residue of the surviving spouse. Should a policy be nominated to a surviving spouse no estate duty is payable on such a policy since it qualifies for the spouse s deduction and therefore no apportionment of estate duty is necessary. Such a policy does not attract estate duty. From the above it is clear that the surviving spouse receives an amount of R as the actual residue of the estate. Her residue for purposes of estate duty must be reduced by the estate duty payable by the estate. Her actual residue is thus R R = R An interesting aspect can be explored which may have relevance on the cash flow of an estate. What if Eric bequeathed cash and the primary residence to the spouse? Stated differently, the question thus asked is if it would make any difference if the last will and testament is changed so that the primary residence plus R cash is bequeathed to the spouse and the residue of the estate to the children? The residue is the value of the primary residence + R = R The quick answer is that more estate duty will be payable since it is more beneficial from an estate duty point of view to bequeath the residue to the surviving spouse. 18 If we do the calculation we will discover that additional estate duty will be payable with the result that less monies will be payable to the heirs of the estate. If the calculation is true, then from an estate duty perspective it is preferable to structure the last will and testament so that the residue is payable to the surviving spouse instead of the children or other third parties. 19 Compare the following calculations for estate duty. The only change is that a direct bequest is made to the spouse instead of the residue. Eric will pay more estate duty. 18 See DM Davis & C Beneke Estate Planning (Online version LexisNexis May 2013 SI 37) par 2.5A. 19 See (Date of use 21 January 2013). See calculation which explains the rationale and cash flows.

24 [24] The relevant aspects are illustrated in cursive. Property - Primary Residence Shares in Toni's Pizza (Pty) Ltd Collective investment scheme Deemed Property - Policy 1 payable to estate Buy and Sell policy on the life of Eric - Policy 2 payable to Belinda Policy 3 payable to Dale Gross Estate Asset Liabilities Bond on Primary Residence Deductions to spouse Policy 2 payable to Belinda Accrual claim Bequests to spouse (residence and surplus cash) Estate Liabilities Master's fees 600 Last expenses Executor's fees Income tax and CGT Net estate A Dutiable Estate Estate duty payable An additional estate duty of R is payable. Notes....

25 [25] Liquidity analysis Cash In Cash Out Policy 1 payable to estate Bond on Primary Residence Collective investment scheme Estate duty payable Shares in Toni's Pizza (Pty) Ltd Master's fees 600 Last expenses Executor's fees Income tax and CGT Accrual paid in cash Children's inheritances Totals Surplus from Estate Notes on liquidity analysis. The liquidity analyses is calculated to determine: 1. If there is sufficient cash in the estate to pay the cash bequests and estate expenses. 2. The cash residue of the spouse. Note that the estate only pays R estate duty. Provident fund proceeds and insurance policies nominated to third parties are not included since it is not part of the estate. The liquidity analyses only takes into account the cash received and payable by the estate. In this instance there is sufficient liquidity in the estate to pay the accrual claim in cash. This is not always the case. The estate has a cash surplus of R which will be paid as part of the residue to the surviving spouse. The actual residue of the spouse after the payment of the estate duty amounts to R It is therefore self explanatory that she will receive the primary residence valued at 2 million plus the surplus (residue of the estate) of R ! The shareholding of Eric was purchased in terms of the buy and sell agreement and therefore creates additional liquidity in the estate. The spouse receives the value of R from the deceased s estate.

26 [26] Cash values accruing to each dependant Belinda (surviving spouse) Belinda Provident fund Policy 2 payable to Belinda Accrual claim Surplus from Estate Less estate duty - Available cash to invest Notes on cash inheritance The purpose of the above calculation is to determine the value of cash assets accruing to the dependants of Eric. Note that the calculation illustrates the cash amounts that she will receive. It must be kept in mind that in addition to the cash amounts she also receives the primary residence. No estate duty must be deducted since the estate duty payable by the estate of R is already accounted for in the surplus she receives from the estate. Dale Dale Provident fund Policy 3 payable to Dale Inheritance Less estate duty Available cash to invest Notes on cash inheritance Dale will only receive cash as his share of the inheritance from the deceased estate, retirement funds and policies. He still needs to account for estate duty payable, namely R since it is not paid out of the residue of the estate. He was the recipient of the life policy to the value of R

27 [27] Genalee Genalee Provident fund Inheritance Available cash to invest Notes on cash inheritance Genalee only receives cash and need not account for any additional estate duty. Tax calculation Belinda While alive Notes on Income Tax GROSS INCOME Salary EXEMPTIONS - Interest exemption - INCOME DEDUCTIONS - Taxable income Plus: Taxable Capital Gain - Total Taxable Income Tax on R % TAX PER SCALE REBATES Primary TAX PAYABLE It is necessary to do this calculation to calculate the budget of Eric and Belinda. Notes

28 [28] Retirement provisions calculation Capital needed Future value of salary needed. PV N 10 I 6 C/FV Calculate PV of capital needed at retirement. BGN MODE PMT N 15 RR 2.83 C/PV In terms of the facts Eric will have R in his provident fund and should therefore have sufficient capital before retirement tax is taken into consideration. The future tax tables at retirement is unknown and have to be taken into account at date of retirement. If we assume that the retirement tax remains the same until date of retirement, it is estimated that approximately 36% of the fund value will be lost to SARS. In such instance tax planning will be necessary to reduce the tax liability at the date of retirement. Note that annuities taken instead of a retirement lump sum (rules of the fund permitting) will not be subject to retirement tax, but the marginal tax rate as and when the annuities accrue to the taxpayer. The marginal tax rate for a person who receives an income of R per annum amounts to approximately 25%, which is less than the 36% retirement tax rate. Notes

29 [29] Maintenance for dependants calculations at Eric s death Belinda needs BGN MODE PMT N 35 RR 2.83 C/PV Belinda has R cash available therefore sufficient capital for her needs. Dale needs BGN MODE PMT N 11 RR 2.83 C/PV Dale has R and therefore sufficient capital for his needs. Genalee needs BGN MODE PMT N 6 RR 2.83 C/PV Genalee has R and therefore sufficient capital for her needs. Notes on calculations This calculation serves to illustrate the capital needed for Eric s dependants at his death. In all instances sufficient capital is available and Eric was correct that sufficient capital is available. It must be noted that the buy and sell agreement

30 [30] provides the bulk of the liquidity, but even if the buy and sell agreement is not honoured, sufficient capital will be available. The purpose of the retirement calculation is to determine if Eric has sufficient retirement capital. Firstly, if the current value of the salary needed is R , then the purchasing power of R in ten years times amounts to R To receive an annual income of R for 15 years, keeping pace with inflation, an amount of R is needed at age 60. The resultant rate is calculated as follows: (9 6) 1,06 = 2,83 Revised Budget including the income tax payable Notes on revised budget Income Expenses Salary Household Expenditure Belinda's income Primary residence bond payments CIS Dividends Medical aid contributions CIS Interest Policy premiums Income Tax - Eric Income Tax - Belinda Total Surplus The final step is the budget of Eric and Belinda taking into consideration the income tax payable. Surplus funds are available each year which can be utilized to purchase additional risk products such as an income protector, additional retirement capital, repayment of debt, etc. Note the dividends and interest income are reinvested and is not included in the budget. The withholding tax on dividends are therefore not relevant for the budget of Eric and Belinda.

31 [31] Self assessment. State whether the following questions are true or false. 1. It is prudent to do the capital gains tax and the estate duty calculation before the accrual calculation since these taxes are taken into consideration in calculating the accrual. False, these expenses are not included in the accrual calculations and it is therefore prudent to start with the accrual calculation. 2. Belinda receives a primary residence from Eric s estate and the base cost of the primary residence when she disposes thereof is 2 million. False, she acquires the same base cost that Eric had, namely R Non domestic policies will be subject to estate duty and capital gains tax upon the death of a deceased. True. 4. The beneficiaries of retirement lump sums are subject to taxation. False, the deceased member is subject to tax but the tax payable may be recovered from a beneficiary. 5. Bequeathing the residue of the estate to the surviving spouse can reduce the estate duty liability of the estate as opposed to a legacy to the spouse of the same value. True, since the residue of the spouse is calculated before estate duty is accounted for. 6. A domestic insurance policy nominated to the surviving spouse attracts no additional estate duty and executor s fees. True, since the policy is not included in the estate of the deceased and qualifies for the spouse s deduction.

32 [32] 7. Domestic insurance policies payable to the estate is included in the accrual calculation. True. 8. All inheritances are excluded from the accrual calculation. False, only inheritances received during the accrual is excluded. 9. Eric and his brother Eugene holds more than 50% of the shareholding in Pizza (Pty) Ltd and it therefore does not qualify for the estate duty exclusion in respect of the policies. False, blood relationship is not relevant to qualify for the buy and sell estate duty exclusion. 10. The shareholding of Eric in Pizza Pty Ltd is not included in property for estate duty purposes since it is in terms of the buy and sell agreement. False, the shareholding is an asset at the date of death and therefore included as property for estate duty purposes. END OF CHAPTER 1

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