How to make the most of your options after inheriting a retirement annuity

21 Jul 2024

A number of avenues are available — taking a lump sum, opting for an annuity or a combination of both; each has its own set of tax implications.

Question: I will be inheriting a retirement annuity from my late father. What are the options open to me?

Answer: A retirement annuity is classed as a pre-retirement product. So, what I say will also be true for a pension fund, provident fund or preservation fund.

With such a product, the trustees of the fund are required by law to ensure that the proceeds are distributed fairly among any dependents. They need not follow the beneficiary nomination in the original contract.

The proceeds of this type of investment will not form part of your father’s estate and will not attract estate duty. The benefits will be paid directly to the beneficiaries, but there are tax consequences, depending on what option you choose. Assuming that the retirement annuity fund trustees have confirmed that you are indeed the beneficiary, here are the options open to you:

Take the capital value as a lump sum

You can take all or part of the retirement annuity’s value as a lump sum. This will be taxed in terms of the retirement lump sum tax rules.

The first R550,000 of the value will be tax-free and the balance will be taxed on a sliding scale up to a maximum of 36%.

Remember that all your father’s retirement lump sums will be aggregated, so if he has taken a lump sum before, this investment will be taxed at the higher rate.

Take an annuity

You can take the benefit as an annuity in your own name. The transfer of the capital value of the retirement annuity will not attract tax, but the income from the annuity will be added to your taxable income each year.

You can choose to receive the annuity in the form of a life annuity or as a living annuity. Remember, the younger you are, the lower the income you will receive from a life annuity. You may be better off by choosing a living annuity.

If you do not need the income, I would recommend that you choose the lowest possible drawdown of 2.5% from the living annuity and reinvest the income in a retirement annuity in order to ensure that you remain in a tax-neutral position.

You have a wide range of investment options open to you with the living annuity. If you do not need to access this investment for an income for a while, you can be aggressive in your choice of investment portfolio. You should be able to generate a return of inflation plus 5% on this investment.

Insider tip

If the beneficiary of the investment does not earn an income, the first R95,750 of the annuity will not attract income tax.

Taking the benefit as an annuity can be an attractive option. I have used this to great effect when the beneficiaries are minors. It can be a great way to pay for the children’s education in a tax-efficient manner.

Combination

You can also choose to receive a part of the benefit as a lump sum and the balance as an annuity.

If there are a number of beneficiaries, of whom one is a salary earner and the rest are minors, then it could be a good strategy for the salary earner to take his or her part of the benefit as a lump sum and for the minors to take the income as an annuity to take advantage of the lower tax rate.

If you choose the right option, inheriting a pre-retirement investment can make a massive difference to your long-term financial wellness. DM

Kenny Meiring is an independent financial adviser. Contact him on 082 856 0348 or at financialwellnesscoach.co.za. Send your questions to [email protected]

This story first appeared in our weekly Daily Maverick 168 newspaper, which is available countrywide for R35.

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Business Maverick

Take the capital value as a lump sum

Take an annuity

Insider tip

Combination