What happens to your retirement annuity when you die?

A retirement annuity (RA) is a voluntary pension plan towards which individuals can contribute in a tax-efficient manner to provide for their retirement years. Unlike pension and provident funds which are occupational in nature, retirement annuities are private and, as such, an employee/employer relationship is not necessary for membership. Subject to a few exceptions, the earliest a member can retire from an RA is age 55, with no upper age limit for retirement, at which point they are required to use at least two-thirds of the fund to purchase an annuity income. But what happens if the member dies before retiring from the RA? How are the funds distributed and to whom?

When a member of a retirement annuity dies before retiring from the fund, the total fund value of the RA becomes payable as a ‘death benefit’. As per the Income Tax Act, the death benefit does not form part of the member’s deceased estate as it is distributed directly to the member’s financial dependants and/or nominees. Importantly, the distribution of these benefits is strictly governed by Section 37C of the Pension Funds Act which places an onerous duty on the RA fund trustees to ensure the appropriate allocation of the death benefit. While freedom of testation remains a fundamental principle of our law of succession, Section 37C is a notable exception when it comes to the distribution of pension fund death benefits. It is also important to note that Section 37C overrides any other laws which stand in contradiction to it.

All pre-retirement products – including pension, provident, preservation and retirement annuity funds – are regulated by the Pension Funds Act, which includes the provisions of Section 37C. The main purpose of this section is to ensure that those people who were financially dependent on the deceased member are provided for financially, regardless of whether a legal duty of support existed or not. This section places a duty on the RA fund trustees to ensure that the member’s death benefits are distributed fairly and equitably amongst his financial dependants and/or nominees, meaning that a member’s nominated beneficiaries may not necessarily receive a portion of the death benefit. This is because a member’s death benefits must be used to provide for the member’s surviving spouse, children, and other financial dependants in the event of his death. The rationale behind this is that the State has granted the member significant tax concessions in contributing to the retirement annuity and, as such, the funds should be used to provide for his financial dependants, thereby alleviating the burden on the State.

Upon the death of the member, the RA fund trustees are required to undertake an investigation to identify the dependants and nominees of the deceased, decide on an equitable distribution amongst those identified, and determine how the payment should be made. Note that a ‘dependant’ can be anyone who was legally or factually dependent on the deceased – and it is important to remember that being identified as a dependant merely means that the trustees are required to consider that person when making a determination, keeping in mind that there are different types of dependants.

A legal dependant, being someone in respect of whom the member had a legal obligation to maintain, could include a minor child, parent, grandparent, or adult child who was still financially dependent at the time of the member’s death. Spouses, cohabiting life partners, civil union partners and customary marriage partners also qualify as dependants. On the other hand, a factual dependant would include anyone that was in fact financially dependent on the member, wholly or in part, even though no legal duty of support existed. Certain dependants, such as an unborn child or fiancé, can be deemed future dependants and should also be taken into consideration by the fund trustees.

A nominee is anyone nominated in writing by the member on the retirement annuity to receive benefits in the event of death, although keep in mind that this nomination is merely a guideline to be used by the trustees when making a determination. If a nominee was financially dependent on the member, then that person should be treated as a dependant and not as a nominee. A nominee’s right to a share of the death benefit is not automatic and depends on several factors such as whether there are dependants and whether the member’s estate is solvent, amongst other things.

The trustees of the retirement annuity fund are required to take proactive steps to trace and identify the member’s dependants, meaning that it is not sufficient for them to merely wait for dependants to come forward. Once the board has identified all dependants and/or nominees, they will need to apply their minds to ensure that an equitable decision is made in accordance with the provisions of the Act. Where the member leaves behind dependants only (whether factual or legal) the fund trustees will need to determine how the funds should be distributed amongst them. Where the member leaves only nominees (i.e. no factual or legal dependants), the trustees are required to wait for a period of 12 months to ensure that no dependants are identified during this period, following which they may distribute in accordance with the member’s nomination. That said, if there is any shortfall in the member’s estate, the trustees are required to settle the shortfall before distributing the balance of the proceeds to the nominees.

Where the member leaves behind dependants and nominees, the fund trustees will need to consider the matter carefully. Remember, the nominee does not need to prove dependency and the fact that he was nominated by the member means that he should be considered by the trustees. When considering the apportionment of the death benefit amongst the identified dependants, the board is required to consider a broad range of factors including, but not limited to, the age of the dependants, to what extent they were dependent on the member, their relationship to the deceased, their current financial positions, their future earning potential, and the amount available for distribution.

If the member leaves behind no nominees or dependants, the death benefit will be paid to the member’s estate provided that it is solvent, although the trustees are required to wait for a period of 12 months to ensure that no dependants are identified during that period.

In the case of a minor beneficiary, it is generally accepted that the trustees can make the payment to the child’s legal guardian, whereas if the beneficiary is age 18 or over the benefit can be paid directly to him. The beneficiary can take a cash lump sum which is subject to tax as per the retirement tax table and in accordance with the deceased member’s withdrawal history. Currently, the retirement tax table allows for the first R500 000 to be tax-free, with any balance above this taxed on a sliding scale. Alternatively, the beneficiary can use the capital to purchase a life or living annuity and, while no tax will be paid when purchasing the policy, the annuity income will be taxed in the hands of the beneficiary. Lastly, the beneficiary can choose to implement a combination of the above.

As is evident from the above, while retirement annuities provide certain tax and estate planning advantages, it is important to understand the implications on your estate plan should you pass away before formal retirement.

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