Life insurance plays a useful role in estate planning and provides financial protection to your family in the form of a death benefit when you pass away.
However, there are only a few cases in which income from death benefits is exempt from inheritance tax.
It is incorrect to believe that life insurance is excluded from a deceased person's estate if a beneficiary is named. Penelope du Plessis, vice president of the South African Institute of Trustees, said naming a beneficiary only exempts the proceeds from executor fees, but not necessarily inheritance tax. This issue requires careful consideration and proper planning.
Proceeds are paid under a domestic life insurance policy and are considered a “deemed asset” of the deceased's estate in the event of the insured's death. Although the income does not physically form part of the estate, it is considered an asset for estate tax purposes. the purpose.
Estate taxes are calculated based on the net value of the deceased's assets after deducting debts. Inheritance tax in South Africa is currently 20% on the first R30 million and 25% above R30 million.
The deceased estate is entitled to section 4A relief, which exempts the first R3.5 million of the taxable estate from estate tax. The reduction or any unused portion thereof may be carried forward between the surviving spouses, who then receive the benefit of their reduction and the carried forward portion.
No inheritance tax
Du Plessis gives four examples where life insurance does not attract inheritance obligations.
- If it occurs to the surviving spouse:
Life insurance proceeds are deducted from the deceased's gross estate. Estate tax law provides that anything inherited by a surviving spouse can be deducted from the estate and is therefore not subject to estate tax. However, the deceased's spouse must be the beneficiary.
- Nominations in prenuptial or postnuptial agreements:
If a prenuptial or postnuptial agreement provides that the surviving spouse and children can benefit from the proceeds of a life insurance policy, these proceeds will be excluded from inheritance tax.
- Insurance premiums paid by third parties (insurance premiums plus 6%):
Du Plessis cites the example of a child paying a parent's life insurance premium and being named as the beneficiary of the insurance proceeds. The value of the proceeds forms part of the estate, but as a deemed asset, the proceeds are reduced by all premiums paid plus her 6%.
Life insurance can be purchased to purchase a business partner's shares in the event that a co-owner of the business dies. However, du Plessis said the insurance must be taken out before the business partner dies and the premiums must be paid by the co-owners.
This insurance will fund the purchase of the deceased partner's shares.
The condition is that the deceased who had taken out life insurance did not pay any premiums.
For the exclusion to be granted, the contract between the partners is important. The Commissioner of the South African Revenue Service (SARS) will need to be satisfied that the policy is aimed at buying back dead shares.
inheritance tax
If the proceeds of an insurance policy form part of the estate for estate tax purposes, the executor will allocate the estate tax payable on the proceeds received by the beneficiaries, heirs, or legatees, and The heirs or legatees are responsible for paying the customs duty on the proceeds received.
Advantages and disadvantages
While life insurance has several benefits, including providing financial security for your loved ones, ensuring liquidity for your estate, paying off debt, and leaving a legacy for your children, it also has drawbacks.
These policies can be expensive, especially if you have pre-existing health conditions.
Additionally, life insurance may lapse due to unpaid premiums.
Your claim may also be denied by your insurance company if information is withheld or inaccurately disclosed during the application process.
Du Plessis advises people to ensure there is enough liquidity within the estate to cover all associated costs, including taxes such as estate tax.
Liquidity
Du Plessis says it can sometimes be wise to name an estate as a beneficiary, especially if you need liquidity to pay debts or taxes. Proceeds are paid directly to the estate and are subject to estate taxes and executor fees.
Currently, the maximum amount that an executor can claim is 3.5% of the total value of assets within the estate, plus 15% value added tax (Vat).
Du Plessis says it's important to review your estate plan at least once a year to determine whether you have enough liquidity and whether your policies are structured correctly. He must consider any inheritance tax and capital gains tax liabilities that may arise from estate planning.
“The last thing you want to do is sell an asset like your home to pay taxes,” she says.
Even if your estate is bankrupt, taxes must still be paid. Sars then looks for someone to pay the taxes. Sars can require the beneficiaries of the estate to pay any unpaid taxes.
Du Plessis points out that in some cases, it may not be wise to name an inherited property as a beneficiary, especially if the family relies on the funds for living expenses while the inherited property is being disposed of. . They can experience financial hardship because it can literally take years for the estate to be liquidated.
Therefore, it is wise to consult a financial advisor or an experienced estate planner when creating and considering your estate plan. This allows it to be tailored to your specific needs and goals and to meet your beneficiaries' short-term income needs.
Provided by the Fiduciary Institute of South Africa (Fisa).
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