Grandparent’s funds: A tax- and cost-efficient strategy
By Martin de Kock (CFP®)
I have an ailing grandparent (80 years old) with R20 million in total cash in a money market fund. They require a small monthly income (R5 000) and would like their beneficiaries to inherit directly at their death, which is imminent. There is no spouse or kids. Which structure is most tax and cost efficient?
When providing financial advice with regards to investments there are various factors that need to be borne in mind. Below are a few of the more important factors to consider:
- Risk profile of the investor as well as their tolerance of risk;
- Time horizon of the investor and investment;
- Objective of the investor – income or capital growth, or both;
- Type of investment;
- Local versus offshore exposure;
- Tax considerations; and
- Estate considerations
Due to the age of your grandparent, the monthly income requirement, and the investment amount available, it’s safe to say that it’s not necessary to take any risk whatsoever. If the intention is to grow the inheritance for the grandchildren, one can consider increasing the risk of the investment to generate increased capital growth, but this would need to be the desire of the grandparent as the client, and not the grandchildren as heirs of the estate.
Investment time horizon
Considering the age of the investor and the statement made in the question “…at their death, which is imminent”, any investment considered cannot be linked to a long period, and needs to be accessible at short notice. An indirect effect of this potentially short timeframe, is that the risk associated with the investment cannot be linked to time – usually the longer the time horizon of the investment, the more risk can be taken in constructing the investment.
Objective of investor
The monthly income objective of the investor is an after-tax income of R5 000 (as per the grandchild’s question). Considering the amount of the available funds to be invested, this requirement is very small. To reiterate, to generate this monthly income for the investor, no risk needs to be taken.
Type of investment
Various investments can be considered which would address the income requirement, not take on any risk, and be tax efficient. Types of investments to consider could be:
- A guaranteed life annuity that escalates annually – to generate the required income of R5 000 per month, and considering the age of the investor, the required capital needed for the guaranteed annuity should be relatively low. Shop around for the best rates as there are numerous providers using different methods to arrive at the guaranteed annuity rates;
- Two-year RSA Retail Savings Bond – investing R774 300 at the current fixed rate of 7.75% (as per rates on 27/7/2017 on rsaretailbonds.gov.za) should provide the R5 000 monthly income required;
- Preference shares in listed companies – the dividends received on these shares are net of dividend withholding tax, thus this income will not cause a tax problem.
The above list are mere examples and not exhaustive. What is critical when assessing which type of investment to use is to bear in mind that the investment cannot be fixed for a long term (taking into account the age of the investor), and needs to be tax efficient.
Local versus offshore exposure
This would only be a consideration if one or more of the heirs were living overseas, or intended going to study or live overseas soon. If this was the case, it would make sense to invest some of the funds in foreign currency. Typically, this would form part of the inheritance of the heir living overseas.
The long-term expectation is that the rand will over time depreciate against other developed market currencies like the US dollar or pound sterling.
In a low-growth environment fees have become more important, as fees reduced the ultimate growth of an investment. There are no fees due on RSA Retail Savings Bonds which can be accessed directly by the investor.
If preference shares are the investment of choice, the fees will be low if accessed directly through a broker and not through an investment platform or unit trust.
Whichever investment vehicle is used, consider the fees applicable.
Any investment considered needs to be readily accessible, as death is ‘imminent’ as stated previously.
The tax threshold of the investor, according to the 2018 tax tables is R129 850 per annum. Including the tax-free portion of interest income, the amount that can be earned before tax is due increases to R164 350. When constructing a portfolio, assuming we know the rate of interest, the capital that generates the interest income can be invested in interest-bearing investments, and the balance in tax-friendly investments like preference shares.
The age limit for contributions to a retirement annuity (RA) have been removed. With the increase of contributions to RAs being increased to 27.5% of gross income limited to R350 000 per year, it makes sense to contribute to an RA from an estate planning point of view.
RAs are excluded from your estate when doing the estate duty calculation. For every year’s contribution to an RA (assuming the annual maximum of R350 000 is contributed) your immediate saving on estate duty is R70 000 (R350 000 x rate of estate duty of 20%).
Note: there’s not enough information provided in the question for me to provide comprehensive financial advice. Please contact us for an appointment.
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