By: Brett Ladouce
When a member of a pension provident fund dies, a death benefit becomes payable under the rules of the fund.
The death benefit does not fall into the estate of the deceased member, but it is rather set aside for the benefit of the dependants and nominees of the deceased member and thus protected against creditors of the deceased estate.
The board of trustees of the pension or provident fund is tasked under section 37C of the Pension Funds Act to:
- Find the dependants and nominees of the deceased member.
- Allocate the death benefit to dependants and nominees of the deceased member in a just and equitable manner.
- Pay the allocated benefits to the relevant dependants and nominees.
Although the board of trustees has a wide discretion to decide how to divide the death benefit of the deceased fund member, trustees must ensure that they act in a just and equitable manner when making their allocation decision, by taking into account:
- The ages of the dependants and nominees.
- The relationship between the deceased member and the dependants and nominees.
- The signed nomination form the member provided to the fund.
- The level of financial dependence of the dependants and nominees on the deceased member.
- The future financial needs of the dependants and nominees.
The allocated death benefits are paid as a lump sum cash benefit, or the fund can purchase an annuity in the name of the dependant or nominee. Most beneficiaries opt for the lump sum cash benefit, without considering the fact that an annuity might be the better option, given their need to replace the income stream that was lost when the fund member died.
When the death benefit is used to purchase a life annuity or a living annuity for the beneficiary, no lump sum tax is payable and the whole benefit is applied to buy the annuity. For beneficiaries who are far from retirement age, purchasing a living annuity might be the most appropriate option for the following reasons:
- The amount used to purchase the living annuity is not taxed. More money is invested, and thus more investment income can be earned in the future.
- All investment income on the invested amount will be tax-free.
- The beneficiary will have the flexibility of deciding the taxable amount that they will withdraw every year, of between 2.5% and 17.5% of the capital amount.
- The annuity does not form part of the assets of the beneficiary. It is therefore protected against creditors, and it does not form part of the joint estate of that beneficiary if they should get married after purchasing the annuity.
- At the death of the beneficiary, the living annuity can be transferred to the nominees of that beneficiary, with the same benefits that the beneficiary enjoyed.
If we, for example, imagine that a death benefit of R3 000 000 is payable to the 50-year-old spouse of the deceased member, the choice between a cash benefit and the purchase of a living annuity in their name can be illustrated as:
As a beneficiary of a death benefit, it might therefore make more sense to replace the loss of the income stream provided by the deceased member with a new income stream that is provided by a living annuity, rather than taking a taxable lump sum cash benefit that forms part of your estate and is therefore not protected against your creditors.
All beneficiaries of death benefits should strongly consider obtaining advice from a financial adviser on the most appropriate choice between a lump sum cash benefit and the purchasing of an annuity, or a combination of the two, based on their needs and preferences.
* Ladouce is a pension funds lawyer and the author of the book, Pensions for Palookas.