Lump sum contributions to retirement annuity a thing of the past
28 July 2015
Posted by: Author: Ronald King
Author: Ronald King (PSG)
Making large lump sum contributions to a retirement annuity purely to avoid estate duties is now a thing of the past.
Retirement reform has been on the agenda since 2007, when the first changes to the taxation of lump sums at retirement and death started. Thereafter in 2009, the taxation of lump sums upon withdrawal changed and the clean break principle with regards to divorces was finally introduced as well. Significant changes were planned to come into effect on the 1st of March 2015 - such as an increase in the tax deductible contributions. Due to pressure from the trade unions, this implementation was postponed to the 1st of March 2016.
Apart from the increase in tax deductible contributions, the focus of the proposed changes was to preserve retirement funds upon resignation and to streamline the taxation thereof; all changes that would benefit workers in the long term. However, it is doubtful whether the concerns of the trade unions will be addressed in 2015 and it should therefore come as no surprise if the alignment and preservation of retirement funds are yet again kicked to the curb in 2016. What did come as a surprise in the 2015 Budget Speech was the manner in which lump sum from retirement funds will now, under certain circumstances, be subject to estate duty upon death.
Since 2009, changes have been made to the Income Tax Act and the Estate Duties Act that make lump sum contributions to retirement funds - and in particular retirement annuities - great estate planning tools. The first change was to exclude lump sums received from a retirement fund upon death from the dutiable estate. The second, albeit smaller, change was to remove the maximum age of 70 from retirement annuities. Finally, the manner in which beneficiaries could commute the retirement fund upon the death of the member changed. Beneficiaries could now decide on which portion of the retirement fund they wished to commute to a lump sum and which portion they wanted to invest into an annuity and receive a taxable income in their hands. The commuted lump sum was taxed in the hands of the deceased as a lump sum from retirement.
This has created the opportunity for taxpayers with large estates that contained liquid assets, such as share portfolios, to make a substantial lump sum contribution shortly before death to their retirement fund. The share portfolio could then, subject to the rules of Regulation 28, be continued within the retirement annuity. The contribution would of course exceed the 15 per cent of non-retirement funding income and was therefore not deductible for income tax purposes. However, when the individual passed away, this lump sum contribution was excluded form estate duty - with a resultant 20 per cent saving in estate duties on the value of the lump sum contribution. Should the beneficiary decide to commute the whole investment, the tax-free lump sum available would be increased by those contributions of the member not previously deducted for income tax purposes. In this case, it would be the entire lump sum contribution. The end result would therefore be that a bequest could be made to anyone without paying estate duties thereon simply by channelling it through a retirement fund. As can probably be expected, Treasury now intends to close down this loophole.
According to the Budget Speech, the Estate Duties Act will now be changed to include, as a deemed asset into the estate, the contributions to a retirement fund as was not previously taken into account as a deduction against income tax. The effect is that any contributions made above the allowable tax-deductible contribution will now, upon death, be included in the dutiable estate. If the proposed changes to contributions mentioned above be incorporated from the 1st of March 2016, this would mean that any contributions above 27.5 per cent of taxable income would form part of your dutiable estate if you did not deduct it from taxable income in later years.
There are a number of questions remaining one this issue and one would have to see the final legislation to determine its full impact. As can be appreciated, this would in effect be retro-active legislation, for although taxpayers may only be taxed at death in the future, the contributions have already been done in the past. It is also unclear who will have to keep track of the contributions and if there is any way to limit the impact of the proposed changes. What is clear, however, is that making large lump sum contributions to a retirement annuity purely to avoid estate duties is now a thing of the past.
This article first appeared on the May/June 2015 edition on Tax Talk.