As individuals plan for the future, a common concern is ensuring the financial well-being of their grandchildren. In South Africa, grandparents can use various strategies to pass on wealth to their grandchildren. According to Kenny Meiring, an independent financial adviser, one approach is to set up a family trust. This allows for control and protection of the assets, with the trust deed specifying how the funds can be used. The trustees can then make payments for education or other expenses without simply handing over the capital to the grandchildren.
However, setting up a family trust can be expensive, with ongoing legal, accounting, and trustee costs. Additionally, trusts are taxed at high rates if income or gains are retained within them. Another consideration is how to transfer the funds into the trust, as donations tax may be payable. Alternatively, lending the money to the trust can bring additional tax and administration requirements. Meiring notes that these factors must be carefully considered when deciding on a family trust.
A second option is to donate the money directly to the grandchildren. However, this approach can be costly due to donations tax. In South Africa, individuals can donate up to R150,000 per year without incurring donations tax. Amounts above this exemption are taxed at 20% until cumulative taxable donations reach R30-million, after which a 25% rate applies. For example, donating R10-million in one year would trigger approximately R1.97-million in donations tax. Meiring suggests using the annual exemption to donate R150,000 each year, which can be useful for education costs or annual support.
A third option is to use retirement money to create an income stream. If an individual is 55 or older, they can contribute to a retirement annuity (RA) and then retire from the fund into a living annuity. This approach offers a tax advantage, as the deduction for retirement fund contributions is limited to 27.5% of the higher of qualifying remuneration or taxable income, subject to an annual maximum of R430,000. Excess contributions can be carried forward and used in future years.
Once retired and transferred to a living annuity, disallowed contributions can be set off against annuity income, potentially making the income tax-free until those unused contributions are exhausted. The individual can then use this income to help their grandchildren. Meiring notes that an individual can donate up to R150,000 per year without paying donations tax, and a couple can potentially move R300,000 a year between them without triggering donations tax.
Using a living annuity provides an important estate planning benefit, as the individual can nominate their grandchildren as beneficiaries. If they elect to continue with an annuity, unused disallowed contributions will not trigger estate duty. However, the grandchildren do not inherit the tax exemption, and subsequent income received from the annuity will be taxable in their own hands. Meiring highlights that this approach allows the grandchildren to inherit an income-producing investment rather than a large lump sum of cash.
The use of a retirement annuity and living annuity offers several advantages, including tax efficiency and control over the capital while the individual is alive. Investment growth inside the RA and living annuity is not taxed in the same way as an ordinary discretionary investment, with no income tax, dividends tax, or capital gains tax payable within the investment itself. Ultimately, the goal is to use the money in a way that helps the grandchildren at the right stages of their lives while minimizing unnecessary tax and costs.
Key points
- A family trust can provide control and protection of assets, but can be expensive with ongoing costs.
- Donating money directly to grandchildren can be costly due to donations tax.
- Using retirement money to create an income stream offers tax advantages and control over capital.
