Life Insurance Tax Benefits

The taxman is very quick about pointing out how much you need to pay, how soon you have to pay it, and what it is that he can stake his claim to. But, when it comes to those few and far in between things that are – dare we say it – tax free, mum suddenly becomes the word.

It is for this very reason that so many people are confused about the tax implications of life insurance payouts. And it is indeed quite hard to believe, if you look at how aggressively your Retirement Annuity is likely to be taxed, that SARS have – for reasons of their own – exempted your life insurance proceeds (under specific circumstances, mind) from tax.

Estate v Beneficiary

The secret of using life insurance as a tax free vehicle lies in how you deal with your policy. When you initially complete your application form, you will have been given two options by your broker where the proceeds of your cover are concerned: The first option will normally be making the cover payable to your estate and the second option is nominating beneficiaries instead.

Estate

On p125 of SARS’ brochure, ‘Taxation in South Africa 2007 / 2008’, they state that: “Where the deceased was ordinarily resident in SA his/her estate will, for estate duty purposes, consist of all property wherever situated, including deemed property (e.g. life insurance policies and payments from pension funds).” Put simply, this means that if you choose to have your life cover paid into your estate, the proceeds will be subject to estate tax.

Under current legislation the tax is applied at a rate of 20% to the dutiable portion of your estate. To calculate the dutiable portion and how much tax you will need to pay, you can use the following formulae:

A – The total value of all your assets. (Note that this will be everything in your estate: cash, shares, stocks, fixed assets, movable assets, proceeds from policies etc.)

B – R 3 500 000. This is the fixed amount that SARS allows you to deduct from the total value of your estate. They usually refer to it as a ‘general deduction’

C – The dutiable portion of your estate

D – 20%. This is the rate of tax applied to the dutiable portion

E – Tax payable by your estate

First calculate: A – B = C;

And then C x D = E.

So, if you estate is worth R 5,000,000 (R 4,000,000 in assets and R 1,000,000 in life cover), then:

R 5 000 000 – R 3 500 000 = R 1 500 000

R 1 500 000 x 20% = R 300 000 in estate tax

Not a pretty picture at all…

Beneficiary

Nominating one or more beneficiary is, under most circumstances the better option. When you nominate a beneficiary, the cover does not form part of the estate, the beneficiary is paid the sum directly by the insurer and the money received, is not taxable at all.

So, given the scenario we painted under ‘Estates’, your estate will now be valued at R 4 000 000 in assets instead of at R 5 000 000 because the R 1 000 000 in life cover will not form a part of the estate. The calculations will work out as follows then:

R 4 000,000 – R 3 500 000 = R 500 000

R 500 000 x 20% = R 100 000 in estate tax

This means that you save R 200 000 in taxes. But, the savings will not stop there; the entire estate will be less costly to wind up because all the fees and duties applied are usually calculated as a percentage of the value of your estate. The lower the value, the lower the costs.

A word on CGT

A further life insurance tax benefit is that your beneficiary will not be required to pay Capital Gains Tax (CGT). On p82 of SARS’ brochure, ‘Taxation in South Africa 2007 / 2008’, under the heading ‘Exclusions’, they clearly state that: ‘An amount received in respect of a long term insurance policy where you were the original owner.’

In closing

If you nominate beneficiaries, the taxation rules currently applied make your life cover one of the very, very few investments in this country that you can leave to them as a tax free inheritance. This casts an entirely new light on life insurance from an investment perspective, now doesn’t it?