A life policy is your greatest investment

The average South African breadwinner faces a number of financial risks that could threaten the stability and security of their family, especially when they’re no longer here.

How can you help your client guard against such risks?

One way would be by saving for that rainy day but the reality is that this isn’t possible for everyone. Another option would be to invest in a life/liquidity policy to provide the necessary cash injection to settle the debts within the estate and the security and income needed for their dependants on their death.

After completing a client’s analysis and assessing their financial position and needs, you must understand how the liquidity policy will holistically impact them and the structure required to ensure you’re providing them with the best advice for their particular needs.

A life policy is a contract between a policy owner and an insurer that provides liquidity to the identified party – either the owner, life insured’s estate or nominated beneficiary. Before entering into this contract of insurance, our clients must understand the various role players and their rights and obligations.

In a life policy you usually find three role players:

  1. Policyholder – the owner of the policy who has full rights to the policy, which includes nominating a beneficiary or beneficiaries. When a policyholder who is also the life insured dies, the policy death benefit will pay to the nominated beneficiary. If the policyholder doesn’t nominate a beneficiary, the death benefit will pay to the estate of the policyholder. If the policyholder isn’t life insured and the life insured dies, the death benefit will pay to the policyholder.
  2. Life insured – the person whose death is being insured against and thus the death benefits of the policy will be paid out upon their death. The value of the death benefit of the policy in the case where the life insured isn’t the policyholder will always be deemed property in the life insured’s estate (with the exception of the three policies listed below under estate duty).
  3. Beneficiary – the person/s or estate entitled to the death benefit of the policy on the life insured’s death.

What effect does cession of a policy have on the nominated beneficiary?   

There are two types of cession:

  • Absolute/outright cession – occurs when an owner of a policy gives up all rights to the policy in favour of a new owner, who becomes the second owner. All the rights and obligations on this policy will transfer to the new owner, who will then also have the right to make new beneficiary nominations, as any previous nominations will lapse.
  • Collateral/security cession– as the name suggests, this occurs when the proceeds of a policy are required as security for a debt incurred. The owner of the policy retains the rights of the policy, but a third party becomes entitled to the proceeds of the policy in proportion to the outstanding debt. Any balance after the debt is settled will be payable to the nominated beneficiary.

Taxes and fees

You must understand and consider the various taxes and fees associated with a life policy in the context of the client’s holistic financial plan.

Income tax

The payer of a policy can’t claim the contributions paid on a risk policy as a tax deduction, with the exception of one type of policy – an employer-owned policy taken out for the purpose of insuring a key person. Should the employer exercise the option to deduct such premiums paid, the effect will be that the proceeds of the policy, which pay to the owner, will be included in the gross income of the employer and taxed at a rate of 28%.

Capital gains tax (CGT)

There’s no CGT payable on the proceeds of a risk policy, provided it’s a pure risk policy with no cash or surrender value.

Note that while there’s no CGT on the policy proceeds, when a policy is taken out for the purpose of a buy and sell, the sale of the shares from the deceased’s estate will have a trigger of CGT, resulting in the estate requiring additional liquidity over and above the proceeds for the purchasing of the shares.

Estate duty

This is a form of wealth tax charged on a net estate over R3,5 million.

When a spouse is the nominated beneficiary on a policy, that policy won’t be estate-dutiable. However, where a beneficiary other than the spouse is nominated, there will be apportioned estate duty on this policy, provided the deceased’s net estate is above R3,5 million. As the beneficiary of the proceeds of this policy will be liable to pay the apportioned estate duty, you may make provision for this tax by increasing the cover required.

While all policies are deemed property in a life insured’s estate, there are three exceptions to this rule:

  1. Buy and sell policy (correctly structured in terms of S.3(3)(a)(iA) of the Estate Duty Act)
  2. Key person policy (correctly structured in term of S.3(3)(a)(ii) of the Estate Duty Act)
  3. Risk policy recoverable by a surviving spouse or child under a registered antenuptial/postnuptial agreement in terms of S.3(3(a)(i) of the Estate Duty Act.

Executors’ fees

The executor may not charge this fee (up to a maximum of 4,025%) on a policy that has a beneficiary nomination.  However, if a policy is left to the deceased’s estate, the executor may charge this fee.

There are a number of additional aspects you must consider in determining a client’s liquidity needs and shortfalls upon death. Some of these include the client’s marital regime, maintenance orders against the estate, transfer fees, and so on.

Losing a loved one is hard enough; having to lose a family home because insufficient provision was made to cover the costs or settle debt would be devastating to anyone. It’s imperative that you guide your client through a holistic financial planning exercise to give them a clear indication of their financial position and needs.

Help your clients secure their future with the legacy of a life policy – their greatest investment.

The next series of articles will continue to unpack some of the technical points raised, helping our intermediaries to understand the practical implications of the solutions we provide to our clients.

For further information and assistance, contact Support Desk: Legal at legal.support@sanlam.co.za or call 0861 113 937.