Presenter: Marius Botha CFP Topic: PCE Exam Training February 2018 Session 2

Transcription

1 Presenter: Marius Botha CFP Topic: PCE Exam Training February 2018 Session 2 Marius Botha mbotha@iafrica.com Agenda Case study with questions and answers Accrual formula for life insurance Section 11F example Section 10C Webinar 2 on 8 Feb 2018 Slide 2 1

2 Case study -The facts Michael and Susan are married out of community of property subject to accrual. In their ante-nuptial contract they both declared their asset values at date of marriage as zero. Michael is 57 years old and Susan is 55. Michael has two children from a previous marriage, George (27) and Esther (24). Both are employed and self-supporting. Susan has a daughter, Jennifer (14), from her previous marriage. Her first husband died 4 years before she got married to Michael in Michael s first wife died in She bequeathed the residue of her estate to him except insurance policies of R to her children so that her net estate was R Michael is employed with Acme Distributors Ltd, a large company that have branches throughout South Africa. He also owns 50% of the shares in Michael Importers (Pty (Ltd), a company that imports Acme s goods from Europe. His brother-in-law and co-shareholder, John, manages Michael Importers (Pty (Ltd). John is 42 years old and owns 48% of the shares. Michael s son George owns 2% of the shareholding. Webinar 2 on 8 Feb 2018 Slide 3 Case study -The facts Michael promised George that he will bequeath his 50% shares in the business to him. Michael only receives an annual dividend distribution from Michael Importers. He gets no salary from the company. Most of the profits are invested back into the company. Michael is happy with that as he wants the business to grow as much as possible so that George can have a good business to take over. George and John have a very good relationship. The company has shown very good growth since it was formed 10 years ago. Michael wants to retire from his employment in order to join Michael Importers (Pty) Ltd on a full-time basis. He does not want to do that unless his retirement capital is sufficient to provide them with the income that they require for their retirement. The rules of his provident fund provide that he can retire, without penalty, at any time after he has attained the age of 55. Webinar 2 on 8 Feb 2018 Slide 4 2

3 Case study -The facts They have the following assets and liabilities: Assets - Michael Base cost Market value Primary Residence Share Portfolio (JSE) Shares in foreign companies % in Michael Importers (Pty) Ltd Portfolio of unit trust funds Cash Investments Motorcar Apartment (flat) in Kenilworth Total value Webinar 2 on 8 Feb 2018 Slide 5 Liabilities Michael Case study -The facts Bond (loan) on primary residence Car loan Total liabilities Notes on Michael s liabilities The original car loan was R and the monthly instalment R The interest rate 10% and the balance of the loan after 2 years is R The interest rate on his housing loan is 9.5% and the remaining term is 8 years (at age 65). The current monthly instalment is R The following are assumed regarding the administration of his estate should he die: The administration fees (executor s fee excluded) is R30 000, and The funeral cost is R Webinar 2 on 8 Feb 2018 Slide 6 3

4 Case study -The facts Michael owns the following life insurance policies on his life: Policy A: A pure risk life policy with no beneficiary nominated with a death claim value of R Policy B: A pure risk life policy. Susan (his wife) is nominated as beneficiary and the death claim value is R Policy C: A pure risk life policy. His children George and Esther are the beneficiaries and the death claim value is R Webinar 2 on 8 Feb 2018 Slide 7 Case study -The facts Assets - Susan Market value Portfolio of unit trust funds (see note below) Cash Investment Motorcar Furniture and Household effects Jewellery Total value Liabilities - Susan Credit card Total liabilities Notes on Susan s assets The portfolio of unit trust funds were bought by Susan with an amount of R that was donated to her by Michael during their marriage. The main reason why this was done is that Michael thought it may be a good idea if she invests the money in an interest bearing investment so that she could be taxed at a lower rate of tax than what he would have to pay. Webinar 2 on 8 Feb 2018 Slide 8 4

5 Case study -The facts After the donation Susan was advised by her financial adviser to invest the money in a portfolio of unit trust funds. It is a pure equity unit trust portfolio and she will receive a before tax dividend of R for the current year. The units have not increased in value since they were acquired by Susan. Michael s current income from his employer is as follows: Annual salary Annual Bonus Med scheme contributions by his employer (R2 200 p.m.) His employer also pays the premiums in respect of two unapproved group life policies which are for Michael s benefit. These policies are: A pure risk life policy with life cover of R This policy will pay to his surviving spouse in the event of his death. The annual premium payable by his employer is R An income replacement policy. The annual premium paid by his employer is R Webinar 2 on 8 Feb 2018 Slide 9 Case study -The facts Michael pays a further R1 500 per month to the medical scheme. He and his wife and Jennifer are the only members. Their qualifying medical expenses that they could not recover from the fund was R Retirement provision Michael is a member of his employer s provident fund. The current value of his retirement interest in the fund is R In terms of an approved group life scheme that is part of the fund, the fund will pay an amount equal to twice his annual salary in the event of his death. This is in addition to the investment value of his interest in the fund on the date of his death. His employer contributes 10% of his salary to the provident fund. Michael does not contribute to the fund. Webinar 2 on 8 Feb 2018 Slide 10 5

6 Case study -The facts He retired from a retirement annuity fund after he turned 55 years old. He was not happy with the fund performance and made the decision to retire and transfer the full benefit to a living annuity. He used the annual drawdown income to pay for his son s university education. His son has now completed his studies. The current value of the assets in the living annuity is R He takes a drawdown amount of 2.5% per annum. His wife s daughter Jennifer is nominated as beneficiary to the living annuity. He has not received any retirement fund lump sums benefits in the past. He would like to receive an income of 70% of his current salary if he is to retire today. He wants this income to be paid until he and his wife reach the age of 77 years. It must increase annually at the rate of inflation (assume 6%). His provident fund benefits, living annuity capital and share portfolio (JSE) must be taken into account as retirement capital, but not any other assets. Webinar 2 on 8 Feb 2018 Slide 11 Case study -The facts He feels that he does not want to use all his assets as retirement capital as he would like his children to inherit from him one day and does not want to use all his assets for retirement purposes. Also, if he takes early retirement to join Michael Importers (Pty) Ltd, he wants to have assets that are not needed for his retirement in case the business needs further funding. He will repay the outstanding balance of his bond when he retires. Michael s monthly cash flow Payments Income Salary (before tax) Living annuity drawdown (R )0.025/ Household expenses Rates and taxes and municipal services Short term insurance Loan repayment housing loan Own contribution to medical scheme Qualifying medical expenses (R ) Existing life insurance Monthly instalment car loan Income tax (not provided) Webinar 2 on 8 Feb 2018 Slide 12 6

7 Case study -The facts Notes to monthly cash flow Investment income is not included in the above cash flow as it is all reinvested and not used to pay their monthly expenses. His annual bonus is excluded from the above cash flow as Michael uses it for their annual overseas holiday. Michael was not sure of the amount of income tax for which he is liable in the year. Michael will receive the following investment income for the tax year: Dividends from pure equity unit trust fund Local dividends from share portfolio (JSE) Foreign dividends Interest on cash investments (6% of R ) Webinar 2 on 8 Feb 2018 Slide 13 Case study -The facts Michael s Last will and Testament In terms of his current Last Will and Testament he bequeaths his estate as follows: He bequeaths his apartment in Kenilworth to his daughter Esther. He bequeaths a cash legacy of R and the shares in Michael Importers (Pty) Ltd to his son George. He leaves the residue of his estate to his spouse Susan. The end of the facts Webinar 2 on 8 Feb 2018 Slide 14 7

8 Case study Question 1 Question 2 Calculate the amount of capital gains tax that will be payable by Michael if he should die today. Webinar 2 on 8 Feb 2018 Slide 15 Solution to question 2 Case study Question 1 Capital gains tax on death The only assets that will not roll-over to his surviving spouse are the following: MV Base cost Cap gain 50% in Michael Importers (Pty) Ltd Apartment (flat) in Kenilworth Less: Annual exclusion Nett capital gain Taxable capital gain (40%) CGT payable at 45% (assumed) Webinar 2 on 8 Feb 2018 Slide 16 8

9 Case study Question 2 Question 1 Calculate the accrual claim that Susan will have against Michael s estate under the Matrimonial Property Act if Michael should die today. Solution to question 1 Accrual calculation - Michael Assets Life insurance payable to the estate Less: Liabilities (R R68 400) Accrual Michael s estate Webinar 2 on 8 Feb 2018 Slide 17 Case study Question 2 Accrual calculation Susan Assets Less: Donation excluded Less: Liabilities minus = = Claim in favour of Susan Webinar 2 on 8 Feb 2018 Slide 18 9

10 Case study Question 3 Question 3 Calculate the residue that will accrue to Susan in terms of Michael s Last Will and Testament if he should die today. Ignore estate duty in this calculation. Webinar 2 on 8 Feb 2018 Slide 19 Case study Question 3 Solution to Question 3 (calculation of the residue) Assets Life insurance payable to the estate Less: Funeral cost CGT Admin fees Accrual claim Executor s fees Liabilities Legacy (cash) Legacy apartment Legacy Shares Michael Importers Residue Webinar 2 on 8 Feb 2018 Slide 20 10

11 Question 4 Calculate the amount of estate duty that will be payable if Michael should die today. Ignore apportionment of estate duty. Solution to question 4 Total assets (as given) Plus: Deemed property Policy A (to estate) Policy B (to wife) Policy C (to children) Unapproved group life Total value of the estate Continued on next slide Webinar 2 on 8 Feb 2018 Slide 21 Question 4 Total value of the estate Less: Deductions Funeral cost Administration fees Executor s fee (3.99% of R ) Capital gains tax Accrual to spouse (section 4(lA) Liabilities Sec 4(q) Policies to spouse Residue to spouse Net estate Less: Section 4A abatement ( ) Dutiable estate Estate duty payable R Webinar 2 on 8 Feb 2018 Slide 22 11

12 Question 5 Question 5 Calculate whether there will be enough cash in Michael s estate to pay all the liabilities, taxes, administration expenses, and cash legacies if he should die today. Ignore apportionment of estate duty and also assume that the accrual claim will not be satisfied in cash. Webinar 2 on 8 Feb 2018 Slide 23 Solution to Question 5 Question 5 Cash liquidity Cash in estate Cash investments Insurance payable to estate Total cash Less: To be paid in cash Funeral cost Administration fees Executor s fee (3.99% of R ) Capital gains tax Estate duty Liabilities Cash legacy to son Shortfall Webinar 2 on 8 Feb 2018 Slide 24 12

13 Question 6 Question 6 Provide Michael with two options that can be used to eliminate the cash shortfall in the event of his death. Advise his as to which of the two options would be the best. Use a monthly premium of R14 per R of life cover if you should recommend life insurance. Webinar 2 on 8 Feb 2018 Slide 25 Solution to question 6 Question 6 Assets will have to be sold if the shortfall is not insured. This means the asset will not roll-over for CGT purposes. The accrual claim will be satisfied if all the assets in the estate, other than the legacies to the children, are transferred to his surviving spouse. This will, however, mean that assets will have to be sold to pay the cash legacy to his daughter. To prevent this life insurance can be taken out on his life. The problem is that any policy payable to the estate will increase the accrual claim by his surviving spouse. The cash shortfall of R does not include the accrual claim. If that is also to be paid in cash, the shortfall will be R (R R ). If the accrual claim is to be paid in cash, additional cash of R is needed. In this case it seems not to be necessary. Continued on next slide Webinar 2 on 8 Feb 2018 Slide 26 13

14 Question 6 It would be best if Michael nominate wife as beneficiaries so that she can, if necessary, pay it into the estate to preserve the assets. In such a case the sum insured should be R Premium = (R /10 000)14 = R910 p. m. Webinar 2 on 8 Feb 2018 Slide 27 Question 7 Question 7 Michael is eager to retire now in order to join Michael Importers (Pty) Ltd. Calculate and advise Michael whether he has sufficient retirement capital to take early retirement today. Assume that he can earn 8% per annum on the capital that he invests and that the inflation rate at which his post-retirement income is to increase annually is 6%. Webinar 2 on 8 Feb 2018 Slide 28 14

15 Question 7 Solution to question 7 Calculation of Retirement shortfall Retirement capital available Living annuity Provident fund Share portfolio = 2 Then = % Income needed after retirement = 70% of = R p.a. Webinar 2 on 8 Feb 2018 Slide 29 Question 7 1 P/YR Begin mode PMT 22 N I/YR PV Shortfall = R ( ) He cannot afford to retire now. Webinar 2 on 8 Feb 2018 Slide 30 15

16 Question 8 Question 8 Advise Michael as to what impact the fact that his wife s daughter is nominated as beneficiary to his existing living annuity, will have on his wife s retirement income after Michael s death. Make a recommendation to eliminate any possible problem. Solution to question 8 If he dies the current living annuity will go to Susan s daughter. That means that Susan s income will be reduced. He should nominate Susan as beneficiary who can in turn nominate her daughter as beneficiary. Webinar 2 on 8 Feb 2018 Slide 31 Question 9 Question 9 Advise Michael as to who is liable for any tax on the dividend income that Susan receives on the investment in the unit trust fund in her name. Solution to question 9 The dividends that Susan receives on the unit trust funds will not be income in her hands as it is exempt from income tax in terms of section 10(1)(k) of the Income Tax Act. It consequently will not be included in Michael s (the donor spouse s) income under section 7(2) of the Income Tax Act. Susan will be liable for 20% tax on dividends. Webinar 2 on 8 Feb 2018 Slide 32 16

17 Question 10 Question 10 Michael wants to know whether a buy-and-sell agreement between the other shareholders is still possible, taking into account that he wants to bequeath his own shares in Michael Importers (Pty) Ltd to his son George. Advise him in this regard and state whether life insurance taken out for this purpose will be exempt from estate duty or not. Solution to question 10 It is recommended that George and John enter into a buy-and-sell agreement. They are both shareholders so that policies will be free of estate duty. They can in future amend the agreement to incorporate the shares that George inherits. The agreement must be in line with the Memorandum of Incorporation. Webinar 2 on 8 Feb 2018 Slide 33 Question 11 Question 11 Do a complete income tax calculation for Michael for the 2017/18 year of assessment. Ignore the taxation of retirement fund lump sum benefits. Webinar 2 on 8 Feb 2018 Slide 34 17

18 Question 11 Solution to Question 11 Income Tax Calculation Salary Draw-down living annuity Bonus Med scheme contributions Group life premium Fringe benefits Income replacement premium Provident fund contribution Interest Foreign dividends Dividends unit trust Dividends shares JSE Gross income Continued Webinar 2 on 8 Feb 2018 Slide 35 Question 11 Gross income Less: Exemptions Interest Dividends Foreign dividends ( ) Income Less: Deductions Retirement fund contributions Taxable income Tax on (2017/18 rates) Less: Primary rebate (under 65) Medical scheme tax credit Additional medical tax credit Tax payable R Webinar 2 on 8 Feb 2018 Slide 36 18

19 Question 11 Calculation of additional medical tax credit Medical Scheme contributions Less: R Plus: Qualifying expenses Less: 7.5% of R % of R R6 464 Webinar 2 on 8 Feb 2018 Slide 37 Question 12 Question 12 Calculate the amount of any other tax that Michael is liable to pay for the year. Solution to question 12 In addition to the above he will also pay tax on local dividends = R Webinar 2 on 8 Feb 2018 Slide 38 19

20 Question 13 Question 13 Michael Importers (Pty) Ltd has recently applied for a loan of R from Orange Bank Ltd. The loan was granted and Michael had to provide surety for the loan in his personal capacity. He is now worried that the bank may claim the outstanding amount from his estate in the event of his death. Advise Michael on how to ensure that the amount will not be claimed from his estate. Further advise him what the tax consequences will be to the company if your plan is implemented by the company. Webinar 2 on 8 Feb 2018 Slide 39 Question 13 Solution to question 13 The company can insure his life for an amount of R as the policy will attract estate duty. Michael and his son own 52% of the shareholding. The company is thus a family company in relation to Michael. In terms of section 4(p) of the Estate Duty Act 48% (percentage of shareholding that Michael owns) of the policy proceeds will be deductible for estate duty purposes. The amount for which his life is to be insured, inclusive of the amount of estate duty that the policy will effectively attract, is calculated as below. Sum insured = R *100/[ (20)] = R Shareholding Michael Webinar 2 on 8 Feb 2018 Slide 40 20

21 Question 13 He and the company must enter into a contract in terms of which the company undertakes to use the policy proceeds for no other purpose but to repay the loan on Michael s death. The premium will not qualify for tax deduction under section 11(w)(ii) as it does not insure the company against a loss. It covers a capital debt. The proceeds will be exempt in terms of section 10(1)(gH) as no premiums qualify for tax deductions. Webinar 2 on 8 Feb 2018 Slide 41 Question 14 Question 14 Advise Michael what the income tax position will be in respect of the unapproved group life policy that will pay an amount of R to his wife in the event of his death. Solution to question 14 The proceeds will be included in Michael s gross income as it is deemed to have been paid to him immediately before death. The proceeds will be exempt from income tax under section 10(1)(gG). Webinar 2 on 8 Feb 2018 Slide 42 21

22 Question 15 Question 15 The rules of Michael s provident fund allow that any portion of the retirement benefit can be taken in the form of a living annuity. Assume that Michael has decided to retire now and that he wants to take a lump sum that, after tax has been paid on it, will be sufficient to repay the current outstanding balances on his car and housing loans. Calculate the amount that he must take as a lump sum in order to repay the two loans. Webinar 2 on 8 Feb 2018 Slide 43 Question 15 Solution to question 15 The aggregate of the two outstanding loans is R Tax on R (2017/18 rates) = R The additional R will attract tax at 18%. The additional amount that must be withdrawn to pay the tax is R = R The total amount to withdraw is R Webinar 2 on 8 Feb 2018 Slide 44 22

23 Question 16 Question 16 Once Michael has retired and joins Michael Importers (Pty) Ltd on a full-time basis, the company will start declaring dividends. Advise Michael what the effective rate of income tax is that will be paid on the profits made by the company if the rate of company tax as well as the new rate of tax on dividends are taken into account. Assume that profits are distributed as dividends. Solution to question 16 On amount of R100 the tax is: Company tax at 28% 28.0 Tax on dividend (R72 0.2) The effective rate is therefore 42.4%. Webinar 2 on 8 Feb 2018 Slide 45 Question 17 Question 17 Assume that Michael dies today before he can retire from his provident fund. Assume that the full provident fund death benefit of R will be paid to his wife Susan. Advise Michael what the options will be that are available to Susan as to the format in which she will be entitled to take the benefit. Advise him what the income tax consequences are in respect of each option and who the person is that will be liable for the income tax. Webinar 2 on 8 Feb 2018 Slide 46 23

24 Question 17 Solution to question 17 Option 1. Take the full benefit as a lump sum. The lump sum tax payable by the estate but can be recovered from Susan. Option 2. Take no lump sum and a take living annuity. Susan will be taxed on annual drawdowns. Option 3. Take a portion as a lump sum and the balance as a living annuity. Michael (his estate) will be liable for the tax on the lump sum but can recover it from Susan. Susan will be taxed on the drawdown amounts. Webinar 2 on 8 Feb 2018 Slide 47 Question 18 Question 18 If Michael should retire today he will require an income of R in the first year of his retirement. The capital that he will have is R This will consist of R in a share portfolio and R in living annuities. His drawdown rate in the first year, if the full income is to be withdrawn from the living annuity, is %. Advise Michael as to how he can restructure his capital drawdown in the first year after retirement in order to pay the minimum amount of income tax in that year. Assume that he retires at the end of this tax year and that the R will be his only income in that year. Webinar 2 on 8 Feb 2018 Slide 48 24

25 Question 18 Solution to question 18 His tax threshold is R (under 65). He must withdraw at least 2.5% of capital (R ). In addition he can earn R in interest without paying tax. He needs another R If he draws this from the capital from the non-living annuity capital this withdrawal will be tax-free. His tax position for the year will be: Webinar 2 on 8 Feb 2018 Slide 49 Question 18 Drawdown (living annuity) Interest Gross income Less: Interest exemption Less: Deductions 0 Taxable income Tax on R Less: Rebate Tax payable The medical scheme tax credit has been ignored. Webinar 2 on 8 Feb 2018 Slide 50 25

26 Question 19 Question 19 Do a new monthly cash flow which takes into account any recommendations that you made in respect of new financial products that are to be taken out by Michael, as well as any other recommendations that you think should be made to improve their monthly cash flow situation. Solution to Question 19 Cash flow It is recommended that Michael should repay his housing loan and his car loan. Continued Webinar 2 on 8 Feb 2018 Slide 51 Question 19 Michael s new monthly cash flow Out In Salary Living annuity drawdown ( *0.025/12) Household expenses Rates and taxes and municipal services Short term insurance Loan repayment housing loan 0 Own contribution to medical scheme Qualifying medical expenses (R ) Existing life insurance New life insurance policy 910 Monthly instalment car loan 0 Income tax (R ) His monthly expenses are reduced by R as a result of repaying the housing and car loans. His surplus is now R Webinar 2 on 8 Feb 2018 Slide 52 26

27 End of case study Webinar 2 on 8 Feb 2018 Slide 53 Accrual Formula to cover cash shortfall P = A + 0.5P + [0.2(0.5P)] + 2[0.0399A] = A + 0.5P + 0.1P A = A + 0.6P P - 0.6P = A 0.4P = A P = A Webinar 2 on 8 Feb 2018 Slide 54 27

28 Section 11F The amount of the deduction in a y. o a. is limited by section 11F to the LESSER of: (smallest of A, B and C) A. R B. 27.5% of the higher of the person s (i) remuneration as defined in fourth schedule (EXCLUDING any RFLB RWB and severance benefit); or (ii) taxable income including taxable capital gain (EXCLUDING any RFLB RWB and severance benefit) BEFORE deducting any deductions under section 11F itself and 18A. C. The taxable income of the person BEFORE the section 11F deduction and also BEFORE inclusion of the taxable capital gain. Webinar 2 on 8 Feb 2018 Slide 55 Calculation Remuneration Salary R 200, Bonus R 20, Fringe benefit fund contributions R 30, Other R - R 250, Income not remuneration Interest R 25, Dividends (local) R 30, R 956, Business (sole proprietor) R 350, Other R - GROSS INCOME R 655, Less: Exemptions Interest R 23, A R 350, Dividends (local) R 30, B R 262, , Other R - R 53, C R 486, INCOME R 601, Less: Deductions (Sec 11F and 18A excluded) R 262, Expenses R 45, Other R - R 45, Tax inc BEFORE sec 11F, sec 18A and TCG R 556, Less: Section 11F (fund contributions) R 262, R 293, Plus: Taxable capital gain R 400, R 693, Less: Section 18A donation R 69, TAXABLE INCOME R 623, R = It can also be interpreted as the R Webinar 2 on 8 Feb 2018 Slide 56 28

29 Section 10C exemption compulsory annuities Section 10C was inserted into the Income Tax with effect from 1 March The section provides an exemption in respect of compulsory annuities. Compulsory annuity is defined to mean the remainder of the retirement interest of a person payable in the form of an annuity as contemplated in a) Paragraph (ii)(dd) of the proviso to paragraph (c) of the definition of pension fund; b) Paragraph (e) to the proviso to the definition of pension preservation fund ; or c) Paragraph (b)(ii) of the proviso to the definition of retirement annuity fund. Webinar 2 on 8 Feb 2018 Slide 57 Non-deductible contributions to retirement funds Section 10C(2) It exempts from income tax compulsory annuity equal to so much of own contributions to a pension fund, provident fund and RA fund that did no rank for deduction against the person s income in terms of section 11(k) or (n) And has not previously been allowed as a deduction in terms of the Second Schedule exempted from normal tax under section 10C in determining taxable income in respect of any year of assessment. Webinar 2 on 8 Feb 2018 Slide 58 29

30 Commentary on section 10C The exemption only applies in respect of a compulsory annuity as defined. The definition does not include a compulsory annuity payable by a provident fund or a provident preservation fund. As from 1 March 2019 it will apply. The exemption only applies to a compulsory annuity acquired by a person after retirement. Subsequent holders of the annuity do not qualify. Non-deductible contributions are aggregated and can be applied against a person s retirement interest regardless of the fund that it was withdrawn from. Webinar 2 on 8 Feb 2018 Slide 59 The End Good luck!! 30