With the silent generation approaching their 80s and 90s and even the youngest baby boomers now reaching retirement age, one factor is set to change the global economy more than any other: inheritance.
Generation X, as well as their younger millennial counterparts, stand to gain from the two richest generations in human history. In fact, in the US alone, an estimated $84 trillion is expected to be transferred to younger generations over the next 20 years. That is roughly $4.2 trillion per year. That is enough money to build 28 International Space Stations every year for the next two decades. Estate planning is thus now more important than ever.
Estate planning involves determining how an individual’s assets will be preserved, managed, and distributed after death. It also takes into account the management of an individual’s properties and financial obligations. Individuals have various reasons for planning an estate, such as preserving family wealth, providing for a surviving spouse and children, funding children’s or grandchildren’s education, or leaving their legacy behind for a charitable cause. Contrary to popular belief, estate planning is not reserved for the ultra-wealthy. Anyone can, and arguably should, consider estate planning.
When a person passes away, their estate generally includes all assets they owned at the time of their death. These assets are then distributed by the executor according to your will. As compensation for not running away with your money in the dead of night, the executor charges an executor fee. This fee is based on the value of your estate. Another significant cost is the estate duty. The estate duty, colloquially known as the death tax, is also based on the value of your estate. In order to maximise the value transferred to your dependants, you need to minimise the value of your estate. Therefore an investment which bypasses the winding-up process is suitable for estate planning purposes.
An example might help illustrate this point.
Assume that Bob has a total net worth of R10 million. Bob did not do any estate planning, so the full value of all his assets will form part of his estate. Estate duties are levied at 20% for the first R30 million and 25% for the remainder of the estate. Executor fees are negotiable, but are capped at 3.5% plus Vat on the gross value of the estate. Bob will thus pass R7.597 million on to his family, with the executor’s fee amounting to R402 500 and the estate duty to R2 million. The family thus only gets about 75% of Bob’s wealth.
Amy also has a net worth of R10 million. Amy, on the other hand, has done estate planning. R2 million of Amy’s net worth is in investments which will not form part of her estate. Amy’s family thus immediately gets R2 million before the winding-up process begins. The remaining R8 million forms part of her estate. Amy’s family will thus receive R6.078 million from the estate, with the executor’s fees amounting to R322 000 and the estate duty to R1.6 million. From the same net worth as Bob, Amy’s family ultimately receives R8.12 million, which leaves them R470 000 better off than Bob’s family.
This leads us to the question: ”Which investments are the best for estate planning purposes?”
The first options to look at are not strictly speaking investments but can help to lower estate duty. In general, estate duty must be paid on life policies, but certain insurance policies are free of estate duty if structured correctly. For instance, if the proceeds of a policy are payable to the surviving spouse or a child of the deceased in terms of a properly registered antenuptial contract (i.e. registered with the Deeds Office) the policy will be totally exempt from estate duty. There are also buy-and-sell policies in which business partners or shareholders insure each other’s lives in order to buy out each other’s shares on death. To qualify as estate duty-free, no premiums must be paid by the person whose life is assured, and the parties must be co-owners of the business at the date of death. Lastly, the proceeds of key person insurance, which covers the life of a “key” person in a business, can also be exempt from estate duty in some cases.
Retirement funds are also a viable option to reduce estate duties and executor fees.
Retirement funds such as retirement annuities (RAs), living annuities, and pension preservation funds allow the policyholder to nominate beneficiaries. Upon the passing of the policyholder, the funds in these retirement funds are passed directly to the nominated beneficiaries, with the notable exception of RAs. The distribution of funds from a RA is ultimately done by the fund’s trustees. The trustees will take the policyholder’s nominated beneficiaries into account, but they are not legally bound to follow the policyholder’s instructions. It is also important to note that if there are no nominated beneficiaries on a retirement fund, the assets will ultimately form part of the deceased’s estate and will thus incur both executor fees and estate duties.
Another investment to consider is an endowment policy.
An endowment policy is a life insurance policy that provides a lump sum payout at the end of a specified term (known as the maturity date) or upon the death of the policyholder, whichever occurs first. Endowments also allow you to nominate beneficiaries, bypassing the winding-up process. A key advantage of an endowment over retirement funds is that with an endowment, you can also nominate a beneficiary for ownership. A beneficiary for ownership inherits the ownership of the investment in the event the policyholder passes away. This allows the investment to continue growing in value. A disadvantage of an endowment policy is that it will form part of the estate for the calculation of estate duty. You are, therefore, only saving on the executor’s fees.
Estate planning is an important yet often overlooked process. Where once it was exclusively for the ultra-wealthy, it is now accessible to far more investors. Investments which are good for estate planning purposes allow the investor to transfer funds directly to their beneficiaries, thereby reducing the estate duty and executor’s fees.
Correctly structured insurance policies can be used to reduce estate duties. Retirement funds allow the policyholder to nominate beneficiaries, thus bypassing the estate, which reduces estate duties and executor fees. Endowment policies allow the policyholder to nominate beneficiaries, as well as beneficiaries for ownership, which also reduces executor fees. However, endowment policies do form part of the deceased’s estate for tax purposes and thus will incur estate duties.