One of clients’ top concerns is how to guarantee the flow of money from their offshore investments when they have passed away (session 17 of our Masterclass series 5). Offshore policy wrappers have become popular investment vehicles, especially for South African tax residents because of the tax and estate planning benefits they offer. Understanding the nuts and bolts of policy wrappers in which clients plan to invest is key to avoiding unintended consequences that could not only affect your clients but also their loved ones – well into the future. Here are some important questions to consider before your clients sign on the dotted line:
- Is it a sinking fund, or an endowment with a life assured?
- Are joint holders allowed?
- What happens on death?
- Does the product allow for alternative beneficiaries?
The investment industry generally uses the term “endowment” not only when it refers to a policy with a life assured, but also when speaking about a sinking fund. While both types of products are endowments, it’s crucial to know whether you are placing your clients’ funds in a policy where there is a life assured or no life assured. The blanket use of the term endowment may also lead to a misunderstanding about the different product rules and how the money/policy moves on the death of a policy owner. So, for the purposes of this article, we will only use the term endowment when referring to a policy where there is a life assured.1 Importantly, a sinking fund is an endowment with no life assured. Both endowments and sinking funds are governed by the South African Long-term Insurance Act and subject to the Income Tax Act.
Understanding the product structure
The following case study from Masterclass session 17 (Scenario 1) is useful to illustrate the types of uncertainties that advisors may have to grapple with when there are joint policy holders, a life assured and nominated beneficiaries. Let’s assume that a husband (H) and his wife (W) each take R11 million offshore and then invest their R22 million together in a global endowment (E) at product provider X. As can be seen in the diagram of Scenario 1:
- H and W are joint plan holders.
- H is the only life assured.
- The two beneficiaries are S and D.
The husband passes away as joint owner and as the only life assured. The following questions arise:
What happens to the policy? Can it be carried over to another person or must the cash be paid out (net of capital gains – CGT – at 12%)?
Who stands to inherit – W the joint plan holder, or S and D who are the beneficiaries?
Scenario 1: What happens to the policy on death and who will inherit?
Source: Ninety One, for illustrative purposes only.
These are just some of the questions that advisors and their clients need to consider before committing funds to an endowment. The way product providers administer and interpret policies can differ substantially; that is why it is essential to read the fine print and interrogate the product structure early in the process. We will unpack some of the issues we have raised here in more detail.
Let’s look at another case study from our Masterclass session 17 of series 5, illustrating some potential challenges when beneficiaries become joint plan holders. We now assume that only H takes R11 million offshore and invests the funds in a global endowment (E) at product provider Y. As can be seen in the diagram of Scenario 2:
- H is the only plan holder.
- H is a life assured and W is a life assured.
- The two beneficiaries are S and D.
Scenario 2: Inheriting a joint plan can pose challenges
Source: Ninety One, for illustrative purposes only.
As there are two life assureds in this scenario (H and W), let’s assume that the policy remains intact and does not need to be cashed in on death. Given that the deceased (H) was the only plan holder, the nominated beneficiaries S and D should inherit the policy as they were nominated upfront to be the beneficiaries for ownership (and not proceeds), which is a further requirement for an endowment but not a sinking fund. Some product providers cannot split ownership between beneficiaries, with each having their own policy. Let’s assume that the policy now moves to S and D as the new joint plan holders.
The complexities of joint ownership
Where an inheritance leads to the beneficiaries of a policy becoming joint plan holders, it may not be a ‘marriage of two minds’. In our example, S and D will now need to co-sign all transactions relating to their policy. These could include repurchases, fund switching, additions or even cashing out the policy. For example, S could be a more conservative investor than D, so agreeing on the underlying investment funds in the policy may be challenging. One joint holder could even block the other to do a switch transaction or repurchase units.
Should D want to cash in some of the policy’s investments, for example, it would lead to a CGT event for both plan holders. Product providers cannot levy CGT on a pro-rata basis. Therefore, one plan holder’s redemption affects the entire policy, with both holders impacted by the CGT. If one plan holder is a spender and the other is a serious investor – it could lead to friction between the two individuals.
What happens if a joint plan holder dies?
If one of the co-owners of a policy dies, their share of the policy will most likely go to the other plan holders and not to the beneficiaries of the deceased plan holder. According to our research, the policy owner ranks higher than the beneficiaries, but the path of inheritance may not be that clear cut. Making assumptions without establishing the facts, could result in the deceased’s wishes not being fulfilled. Fully understanding the product structure and the functionality of the product provider is crucial. Even though a policy could have a single owner, if there is more than one beneficiary inheriting, it could create joint ownership on the death of the policy holder – depending on how the product has been designed.
Avoiding unintended consequences: Ninety One’s approach
Complex product structures could make it challenging (and costly) to ensure the successful transfer of a client’s offshore wealth to loved ones, as illustrated above. Having the appropriate offshore product structure in place can remove many of these estate-planning worries over the lifetime of a client and after their death.
The Ninety One Global Life Portfolio has been designed to take the guesswork out of estate planning. It is a sinking fund policy (no life assured), and beneficiaries inherit separately from each other. Importantly, the Ninety One Global Life Portfolio allows for only one owner. If the policy owner dies, the only person who has the right to inherit is the beneficiary – there are no joint owners who could lay claim to the benefits. Besides beneficiary nominations, we also offer alternative beneficiaries. Scenario 3 is an example of the Ninety One Global Life Portfolio in action.
Let’s assume that H takes out R11 million offshore and then invest the funds in the Ninety One Global Life Portfolio. The diagram of Scenario 3 shows that:
- H is the only owner – no joint owners are allowed.
- There is no life assured as this is a sinking fund policy (S).
- W is the beneficiary.
- S and D are alternative beneficiaries.
Scenario 3: Ninety One Global Life Portfolio – the advantages of a sinking fund policy
Source: Ninety One, for illustrative purposes only.
H passes away as owner. The beneficiary, W, can elect to:
- Have the policy proceeds paid in foreign currency into a bank account outside South Africa, net of capital gains tax deducted within the policy of 12%, or
- Have the policy proceeds paid in rands into a bank account in South Africa, net of capital gains tax deducted within the policy of 12%, or
- Keep the policy in place (become the new policy owner) and then the capital gains rolls over (the capital gains tax roll-over applies to any beneficiary and not only the spouse selecting to keep the policy).
Sinking fund policies offer more choice to nominated beneficiaries as they are always free to take over the policy should they prefer this option to a cash pay-out. In contrast, endowments have to pay out on the death of the last life assured. Should W in our example decide to keep the Ninety One Global Life Portfolio (sinking fund policy) in place, the investment term would fall away – even if the policy had only been in force for a short time. On death, the new policy owner of the Ninety One Global Life Portfolio inherits a mature policy.
The role of alternative beneficiaries
Let’s assume in the above example that the beneficiary, W, had already passed away when the owner, H, died. The two alternative beneficiaries, S and D, will now inherit the policy, as illustrated in Scenario 4. They will each own a separate policy, should they wish to keep the policy and not take the proceeds. S and D can further benefit from family pricing on the Ninety One Investment Platform. Ninety One Family Office removes the need for joint accounts as it offers cost efficiency to families who choose to consolidate their assets on our platform. This functionality also paves the way for intergenerational succession planning and bringing other family members into the advice net. Because S and D own separate policies, they can choose to nominate their own family members as beneficiaries and alternative beneficiaries (Scenario 4).
Scenario 4: Ninety One Global Life Portfolio allows for the successful transfer of offshore wealth
Source: Ninety One, for illustrative purposes only.
S and D also have the flexibility to cash in their own policies at any time in the future without having to get the permission or signature of each other. Because they inherited separately, it also means that if one of them makes a redemption or decides at a later stage to cash in the policy, the other policy owner will not incur CGT. It’s important to note that if no nominated beneficiaries are alive on the death of a policy owner, and no alternative beneficiaries are in place, policy proceeds would have to be paid out to the estate, incurring both capital gains tax and executor fees.
Spouses taking money offshore – rather be a beneficiary than a joint owner
In this article we have highlighted some of the issues that could arise with joint ownership. Where spouses wish to invest their annual offshore allowance of R11 million each, both spouses can enjoy the benefits of owning a separate Ninety One Global Life Portfolio without incurring additional fees, thanks to family pricing on our platform. If you have two separate policies with each owner nominating their spouse as a beneficiary, no executor fees will apply if one of the policy owners die.
On the flip side, if both spouses owned one policy jointly and one of them died, the executor would have to deal with the deceased spouse’s portion in the estate, charging executor fees. As mentioned earlier, the Ninety One Investment Platform does not allow for joint ownership because of the many challenges it poses.
In conclusion
Offshore policy wrappers remain attractive investment vehicles for South African residents seeking tax and estate-planning benefits. Both sinking fund policies and endowments have a role to play in meeting clients’ needs. However, it is crucial to have a deep understanding of the product structures in which your clients wish to invest to avoid unintended consequences. The way product providers administer and interpret the various laws governing policies can differ substantially. So, look under the bonnet before it is too late.
1 Endowments offer protection from creditors while sinking fund policies do not. However, this protection only kicks in after the policy has been in force for at least three years. Please note, there may be additional requirements such as that the policy benefits must be payable to a person that is also the life insured under the policy or the spouse of that life insured. It would be best to confirm the specific requirements with the product provider.