Understanding Death Benefits in Retirement Plans

Have you thought about what happens to your retirement savings after you are gone? These assets don’t disappear; they are vital financial support for your family. The way these funds are distributed depends on the retirement product you own. Pension funds, provident funds, retirement annuities, preservation funds, and living annuities each have unique protocols regarding death benefits.

Living annuities: Quick and uncomplicated

A living annuity offers you an income from your retirement savings after you retire. You have the ability to select your annual withdrawal amount (from 2.5% to 17.5% of your investment value). This financial arrangement is governed by the Long-Term Insurance Act and the Income Tax Act.

Upon your passing, the beneficiaries named in your annuity contract will receive the remaining investment.

• You can change your beneficiaries at any time. If you do not update them, such as after a divorce, the named beneficiary will still receive the benefit, as the insurer cannot change your choice.
• If no beneficiaries are designated, the benefit will go to your estate, which may be subject to tax.
• Living annuities are not covered by Section 37C of the Pension Funds Act, meaning trustees do not play a role. This leads to a more streamlined and predictable process, allowing beneficiaries to access benefits without waiting for estate closure.

Retirement funds: The trustees’ involvement

Retirement funds, which include employer pension and provident funds, preservation funds, and retirement annuities, have different rules. These savings fall under the governance of Section 37C of the Pension Funds Act, which mandates trustees to decide how your funds are distributed after your death.

This regulation aims to protect your dependents, but it may mean your wishes are not fully respected. For instance, if you’ve named an ex-spouse as a beneficiary but no longer support them, the trustees might opt not to provide benefits to them.

The process explained

• Submitting a beneficiary nomination form is crucial as it informs trustees, although it isn’t legally binding.
• You can nominate dependents and also include individuals who do not rely on you financially.
• Retirement funds are separate from your estate, thus cannot be distributed through your will.
• Your nomination form does not substitute for a will; a valid will is still essential for distributing your other assets. If you don’t have a will, the Intestate Succession Act will dictate the distribution, which might not align with your preferences.
• Some funds may provide an ‘Infund’ living annuity. Since these funds remain within the retirement fund, trustees will still apply Section 37C for distribution decisions.

Considerations for trustees

Trustees are tasked with identifying and evaluating all potential beneficiaries before finalizing any distributions. They consider factors such as:

• Financial dependence, relationship dynamics, and the ages of beneficiaries.
• Individuals you support financially, even if they aren’t officially classified as dependents.
• Second families, regardless of legal recognition or awareness.
• Adult children are considered dependents but may not necessarily receive a portion of the benefits.

The trustees aim for fair distribution, which may not align with your nomination form. For example, if you designate your spouse as the exclusive beneficiary, trustees might opt to allocate some benefits to your minor children. In such cases, the children’s benefits are usually placed (post-tax) into a beneficiary fund or trust, ensuring that the funds are available for daily necessities until they reach maturity.

This process can take time, potentially lasting up to a year, as trustees must thoroughly assess and confirm all dependents before making final decisions. No distributions are made until this process is complete.

Options available to beneficiaries

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• As a cash payout (after tax);
• By transferring it into their own living annuity (with no immediate tax deduction); or
• A hybrid of both methods.

This flexibility allows beneficiaries to customize their inheritance based on their financial needs.

Any cash distributed is taxed under the deceased’s name, in accordance with the retirement lump-sum tax tables (rather than income tax rates). Tax will be applied in proportion to each beneficiary’s allocation.

Understanding the laws associated with different products enables families to prepare, manage expectations, and make informed choices.

To protect your loved ones:

• Regularly update your beneficiary nomination forms.
• Ensure you use the correct format required by your living annuity provider.
• Review your beneficiaries after significant life events such as marriage, divorce, or the birth of children.
• Keep a current will to address your other assets.

Taking these steps will help ensure that your family faces less uncertainty or financial stress during a challenging time. Seek advice from a financial advisor for assistance in structuring your estate for optimal support of your beneficiaries.

Rita Cool ‒ Head of Retail Best Practice at Alexforbes.

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