The useful role of life policies in estate planning (2024)

Brought to you by Fisa

Life policies play a useful role when developing your estate plan, offering financial protection in the form of death benefits for your family when you are gone.

However, there are only a few instances where the proceeds from death benefits will be exempt from estate duty.

The perception that a life policy will be excluded from the deceased estate if there is a beneficiary nominated is a fallacy. A beneficiary nomination will only ensure that the proceeds are free from executor’s fees, but not necessarily estate duty, says Penelope du Plessis, vice-chair of the Fiduciary Institute of Southern Africa. The matter requires careful consideration and proper planning.

Proceeds are paid under domestic life insurance policies and in the event of the insured’s death are considered a “deemed asset” in the estate of the deceased, The proceeds will not physically form part of the estate but are considered as an asset for estate duty calculation purposes.

Estate duty is calculated on the net value of the deceased’s assets after deducting any liabilities. In South Africa estate duty is currently 20% of the first R30 million, and 25% on anything over R30 million.

The deceased estate is entitled to a Section 4A abatement, where the first R3.5 million of the dutiable estate will be exempt from estate duty. The abatement, or any unused portion thereof, can roll over between surviving spouses who will then benefit from their own abatement plus any portion rolled over.

No estate duty

Du Plessis sets out four instances where a life policy will not attract estate duty:

• When it accrues to the surviving spouse:

The proceeds from the life policy are deducted from the gross estate of the deceased. The Estate Duty Act stipulates that anything inherited by the surviving spouse is deductible from the estate and is therefore not subject to estate duty. However, the spouse of the deceased must be the nominated beneficiary.

• Nominations in ante or post nuptial contracts:

Where provision was made for a surviving spouse and the children to benefit from the proceeds of a life insurance policy, in the ante or post nuptial contract, these proceeds will be excluded for estate duty purposes.

• Premiums paid by a third party (premiums plus 6%):

Du Plessis gives the example of a child paying for a parent’s life policy and being nominated as the beneficiary of the proceeds of the policy. The value of the proceeds will form part of the estate, but as a deemed asset the proceeds will be reduced by the amount of all the premiums paid plus 6%.

• Buy-and-sell agreements:

A life policy can be taken out by a co-owner of a business to buy the shares of their business partner in the event of death. However, says Du Plessis, the policy must be taken out before the death of the business partner and the premiums must be paid by the co-owner.

The policy funds the purchase of the deceased partner’s shares.

It requires that no premiums were paid by the deceased whose life was insured.

The contract between the partners is important for the exclusion to be granted. The commissioner of the South African Revenue Service (Sars)will need to be satisfied that the policy was intended for the purpose of repurchasing the deceased shares.

Estate duty

Where the proceeds of a policy form part of the estate for estate duty purposes, the executor will apportion the estate duty payable on the proceeds received by the beneficiary, heir or legatee – and they will become liable to pay the duty on the proceeds received.

Benefits and drawbacks

Although life policies have several benefits – such as providing financial security for loved ones, ensuring liquidity in the estate, paying off debts or leaving an inheritance for the children – there are also drawbacks.

These policies can be expensive, particularly if you have a pre-existing health condition.

In addition, unpaid premiums may result in the life cover lapsing.

There is also the possibility that claims may be rejected by the insurance company in the event of non-disclosure or inaccurate disclosure of information during the application process.

Du Plessis advises people to ensure there is sufficient liquidity in their estate to cover all associated costs including tax liabilities such as estate duty.

Liquidity

Du Plessis says there are instances where it may be prudent to nominate the estate as the beneficiary, particularly if there is a need for liquidity to pay debt or taxes. The proceeds will be paid directly into the estate, attracting estate duty and executor’s fees.

Currently the maximum amount that an executor can charge is 3.5% of the gross value of the assets in the estate, plus value-added tax (Vat) at 15%.

Du Plessis says it is important to review your estate plan at least once a year to determine whether it has sufficient liquidity and whether policies are structured correctly. You should consider any potential estate duty and capital gains tax liabilities that may arise from your estate plan.

“The last thing you want is to sell an asset like a house to pay your taxes,” she says.

Even if your estate is insolvent, the taxes must still be paid – and Sars will look for someone to pay them. Sars can require the beneficiaries of the estate to pay the outstanding tax liability.

Du Plessis notes that in some instances it may be ill-advised to nominate the estate as the beneficiary, especially if the family depends on the funds for living expenses while the estate is being wound down. They may experience financial hardship as it can literally take years for the estate to be wound up.

It is therefore sensible to consult with a financial advisor or an experienced estate planner when developing and reviewing your estate plan. This will ensure that it is tailored to your specific needs and goals and can cater for the short-term income needs of beneficiaries.

Brought to you by the Fiduciary Institute of Southern Africa (Fisa).

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