Group Life Cover - Beware Of The Tax Implications
Approved or unapproved death benefits – beware of hidden tax implications for loved ones
Knowing whether your death benefits are approved or unapproved in terms of the Pension Funds Act may save your loved ones from any unexpected tax surprises at an already difficult time.
“The nature of death benefits rarely gets enough attention from ‘the living’ but the tax implications of this benefit can become a substantial burden on the beneficiaries you intend providing for,” says Celeste Kruger, Consultant - Employee Benefits Consulting, at leading financial advisory business, GTC.
Death benefits from retirement funds are subject to the requirements of Section 37C of the Pension Funds Act, and they are taxed in terms of the Second Schedule of the Income Tax Act (see scales at the end of the article).
“Most employers provide for a death benefit – usually a lump sum amount – to employees in addition to a retirement benefit. But the way in which this benefit is structured, determines the tax treatment thereof in the event of death.” Kruger explains. “In most cases, employers would include the premiums in respect of death benefits in the contributions to the retirement fund. This is referred to as an ‘approved’ benefit, meaning it is recognised by the Registrar of Pension Funds and approved by the Commissioner of the South African Revenue Service (SARS) for tax deduction purposes.
Kruger adds that should the employee pass away whilst in service of the company, the death benefit will be paid to the deceased’s dependants or nominees as agreed by the Trustees, through the retirement fund. However, since it is paid from the retirement fund, it will be deemed to form part of the retirement benefit, and therefore it will be taxed.
“The implication is that the deceased employee’s dependants or nominees may receive considerably less of the expected benefit, due to the tax deduction, on any pay out greater than R500 000,” she continues. “This reduction may be quite significant, depending on the quantum of death benefits received.”
She says that the beneficiary may choose to utilise the death benefit to purchase an annuity – instead of receiving the lump sum.
“In this instance, the benefit will not be taxed upfront, but considered as income drawn over time, and taxed according to Pay As You Earn (PAYE) tax tables.”
How to avoid this tax liability
According to Kruger it is possible to avoid this tax liability at death.
“An employer may provide death benefits directly through an insurer, by paying the premiums to a separate employer-owned group life assurance policy, instead of to the retirement fund. These are referred to as unapproved benefits, and are not recognised as a retirement benefit by either the Pension Funds Act or SARS,” she says.
“The benefits will still accrue and pay out. This time, however, the benefits will be tax-free in the hands of the appointed beneficiary. The employee will be taxed on the monthly contributions towards the unapproved group life assurance, as this will be deemed a fringe benefit provided by the employer and therefore considered as part of gross income.” Added to this, the beneficiary appointment will be unencumbered by the Section 37C Pension Fund Act limitations on the selection of dependants or beneficiaries.
If the benefit is considered a fringe benefit, the employer will be able to deduct the premiums from its income, for tax purposes.
“What may seem like a trivial detail, can have a major impact at a difficult time, so we encourage employees to find out what their death benefit status is, and specifically whether it is approved or unapproved. This would enable them to prepare their affairs accordingly and provide their dependants with peace of mind,” Kruger concludes.
Tax scales of the Second Schedule of the Income Tax Act:
How well do you understand your death benefit?
As members of a retirement fund, most of us are aware that there is a lump sum death benefit (usually expressed as a multiple of your annual salary), over and above any accumulated savings, that will be payable on death.
However, how well do you understand how or if the amount is taxed, and to whom it will be paid?
Approved death benefits
If the cover is provided under a tax-approved pension or provident fund, this is referred to as “approved” cover. The policy is held by the retirement fund for the benefit of the members.
Member contributions to approved retirement funds are tax-deductible up to 27.5% of remuneration.
However, the death benefit is subject to tax – which needs to be taken into account when calculating how much death cover you have.
Death benefits will be distributed to dependants and/or nominees in terms of Section 37C of the Pension Funds Act. It is important to understand that fund trustees may depart from a completed nomination form in order to comply with the Act.
All benefits (lump sums and pensions) paid from an approved retirement fund are exempt from estate duty.
Unapproved death benefits
If the cover is provided under a separate (free-standing) group life insurance policy this is known as “unapproved” cover. The policyholder is the employer or company on behalf of the members.
Please note that “unapproved” cover simply means that it is not offered under a tax approved retirement fund, and doesn’t affect its legitimacy in any way.
Contributions in respect of unapproved cover are not tax deductible. However, the full benefit is tax free, and the policy proceeds will be paid according to the wording in the policy (usually to a nominee, the deceased estate in the absence of a nominee, or to the dependants and/or nominees in proportions determined by the employer).
The lump sum benefit will be subject to estate duty. However, the value of any benefit received by a surviving spouse as a result of the death of the member is deducted from the estate before estate duty is calculated.
It’s important to know whether your retirement fund death benefits are “approved” or “unapproved” to understand if the lump sum will be subject to tax or estate duty, and what the extent of the potential liability is likely to be.
Speak to a financial adviser if you are unsure, as you will then be able to assess if your life cover is sufficient or not.
Want to discuss your benefits and options then give me a call, Warren Basel on 082 290 5182 or email warrenb@oraclebrokers.com
