Can I open an RA for my mom then convert it into a living annuity?

Retirement annuities (RAs) and living annuities are wonderful estate planning tools since they both fall outside an individual’s estate. There is no age restriction or limitation when a RA can be started, and the earliest retirement age is 55. This means that your 78-year-old mother can start a new RA at any time and retire from it as soon as she wishes to.

I assume that your idea to move the funds from your mother’s savings account into a RA and then into a living annuity is to remove the proceeds from her estate to reduce estate duty in the event of her death. Investing in a RA and retiring from it soon thereafter is 100% legal. However, removing the proceeds from your mother’s estate does have some challenges.

When winding up an estate, an abatement of R 3.5 million applies. In simple terms, this means that the first R3.5 million is distributed tax-free, and the value exceeding R 3.5 million will be subject to estate duty of 20%. Should her estate be valued at more than R30 million, the excess amount above R30 million will be taxed at 25%.

Considering this, it will only really make sense to move her cash to a RA if her estate is worth more than R3.5 million.

There is, however, another caveat. As you know, contributions towards RAs are tax deductible. The maximum deductibility amounts to 27.5% of taxable income with a maximum contribution of R350 000 per year. Where contributions exceed either or both of these limits, they are classified as “disallowed” contributions. The classification refers to disallowed as a tax deduction and not disallowed in general. Where there are “disallowed” contributions, they roll over to the next year, where their tax deductibility will be tested again.

If your mother earns taxable income, which I assume she does, even if it’s only from interest earned from the cash that you intend to move, she will qualify for the appropriate tax deduction. The disallowed portion will keep on rolling over until it has all been claimed as tax deductions in future years, or until she retires from the RA and invests in a living annuity, or passes away.

The tricky part and the effectiveness of your strategy will depend on how long your mother lives and how much of the RA contributions were accepted as deductible. The disallowed contributions will have two advantages during the retirement process from the RA and the income derived from the living annuity.

Firstly the tax-free portion of the commutation (should she commute a portion to cash) will be higher than R550 000 because the disallowed portion will be paid out tax-free (within the one-third limit) over and above the R550 000.

That is, of course, assuming a commutation value of more than R550 000. The remaining disallowed contributions will provide tax-free income paid by the living annuity.

Upon your mother’s death, the living annuity will fall outside your mother’s estate. However, the disallowed contributions that remain within the living annuity that provided tax-free income will be included in her estate as an asset and attract the stipulated estate duty.

What you must also be aware of is how the proceeds are treated on death.

Even though one can nominate beneficiaries on a RA, the trustees of the retirement fund will ultimately determine who receives what portion of the capital that is invested in the RA. The trustees will take into consideration if beneficiaries were nominated on the RA and what allocation was requested to be paid to them. They will also consider divorce orders, family structures, blood relatives and if any parties were financially dependent on the deceased. Once they have all the information in hand, and after consulting with all potential beneficiaries, they will allocate the funds. You will understand that this can take some time, and a speedy payout is unlikely. The executor of the estate will have nothing to do with this process.

Where the funds are already in a living annuity, the process is much less complicated, and settlement is quick. In this scenario, the underwriter of the living annuity will act on the beneficiary nominations and honour the annuitant’s wishes by either paying out the proceeds in proportion to the beneficiary nomination or issuing a new living annuity in the name of the beneficiary. The beneficiary has the choice of which option to choose.

Bear in mind that cash payouts will attract tax based on the retirement tax tables and can be as high as 36% depending on the previous cash withdrawals the annuitant made over the extent of their life.

Where the beneficiary elects to rather receive a living annuity with their portion of the funds, the transfer to the new living annuity will be done at par value without any taxes deducted. The beneficiary can also choose a combination of cash and a living annuity subject to the minimum investment requirements of the administrator of the living annuity. Failing to nominate beneficiaries will lead to the proceeds being paid to the deceased’s estate and distributed according to the deceased’s will. If there is no will, then the proceeds will, together with all the other assets of the deceased, be distributed according to the intestate succession rules.

Taking the above into consideration, you will understand the importance of nominating a beneficiary (or beneficiaries) on a living annuity.

I hope the above has helped. All the best with the structuring of your ageing mother’s financial affairs.