Financial Estate Planning - Beat Tax on Death

The Weekender / Business Day 11/12 March 2006

Why is financial estate planning important?

Well, there is truth in Benjamin Franklin's saying "Nothing in this world is certain but death and taxes"

Estate duty involves both these aspects, as it is a tax payable upon death. Upon your death, all your assets (including property, investments and cash) and liabilities form your estate. In terms of the Estate Duty Act, your estate has to pay estate duty.

Financial estate planning is an important part of the financial planning process. Proper financial estate planning may minimize estate duty and ensure that there is sufficient cash to pay liabilities. Also, remember that death is a capital gains tax event. This means that at your death all your assets are valued and compared to the value of these assets at the date of acquisition. Any gains made on these assets may be subject to capital gains tax.

If there is not sufficient cash in the estate this may result in the forced sale of assets which form part of the estate. Estate duty and CGT is only now coming home to bite Mr. and Mrs. Average, who never thought that they would be eligible for wealth taxes.

By way of an example, I will illustrate a simple way to save money on estate duty through proper financial estate planning.

Mr. and Mrs. Smith are a married couple, Mr. Smith dies and his estate is valued at R5m. In his will he bequeaths his entire estate to Mrs. Smith. Mrs. Smith will receive the R5m and the entire amount will also be deductible for estate duty purposes, as you do not have to pay estate duty on assets you leave to your spouse.

But, there is a catch. Leaving your entire estate to your spouse, simply defers the tax payable by the surviving spouse, payable on the combined value of the assets in both estates.

In our example, if Mrs. Smith dies and her estate remains valued at R5m, she may use the R2,5m abatement. Thanks to Trevor Manuel, this amount has been increased from 1 March 2006 to R2,5m from the R1,5m as it was previously. Mrs. Smith may deduct R2,5m from her estate and bequeath her entire estate to her children.

The total estate duty payable by her estate will be R2,5m multiplied by twenty percent, which is R500,000.

In the absence of proper financial estate planning and adequate liquidity, many estates will have to realize assets to settle this amount.

Using the same amounts, if Mr. and Mrs. Mofokeng were to use a trust the estate duty payable could be substantially reduced. Mr. and Mrs. Mofokeng’s will could be drafted in a manner to take advantage of the R2,5m abatement. Each spouse should bequeath the residue of their estate to the surviving spouse less the R2,5m abatement. The R2,5m abatement could be bequeathed to an inter vivos trust or a testamentary trust.

Bear in mind that the surviving spouse and children can be nominated as beneficiaries of the trust. In so doing, the wife or children will enjoy the benefits of the assets in trust. A testamentary trust is established in terms of a will and comes into operation upon death. An inter vivos trust is established during a person’s life.

In our example, if Mr. Mofokeng bequeaths R2,5m to Mrs. Mofokeng and the remaining R2,5m to a trust, the R2,5m to Mrs. Mofokeng will be deductible and the R2,5m bequeathed to the trust will be exempt in terms of the abatement. Mr. Mofokeng’s estate will therefore have no estate duty liability.

If Mrs. Mofokeng dies and her estate remains valued at R2,5m, she may use the R2,5m abatement. Therefore R2,5m may be deducted from her estate and her entire estate may be bequeathed to her children. Remember that R2,5m is still held in trust for the benefit of the children. Now, there will be no estate duty payable. The use of the trust has resulted in an estate duty saving of R500,000.

There are many advantages of trusts in financial estate planning. Trusts may also be used to achieve what is referred to as estate freezing.

In this instance a person will sell assets which he or she expects to increase substantially in value to a trust, of which his or her children are the ultimate beneficiaries. The growth of the assets will take place in the trust and be excluded from his or her estate. Trusts also provide asset protection against creditors.

However, trusts may be expensive from an administrative and compliance point of view. Trusts also impose onerous duties on their trustees.

Morne Bezuidenhout, one of my colleagues who has a legal background, points out that due to the complexities of trusts, it is vital that the decision on whether or not to form a trust should be taken with expert financial estate planning advice.

If you already have a trust structure similar to that explained above, I recommend that you amend your will to make use of the R2,5m abatement. I suggest that for the purposes of estate financial planning and general financial planning advice you choose a qualified financial planner holding the CFP qualification. I repeat my previous advice: if you cannot get a referral from a satisfied client who you respect, go to www.fpi.co.za, select three financial planners, have a coffee, interview them and possibly even two of their clients.

Debbie Netto-Jonker, CFP™, is founder of Netto Financial Services and was financial planner of the year in 2001.