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Feel free to reach out to PSG Wealth Manager  Patrick Duggan  directly.

Aspirations

We all have a few deeply human aspirations, that we would do well to remember and prioritise. The best way to design a sensible plan to achieve these is to state them in human terms, and not those of the financial industry.

Throughout our work with families like yours, we have found that there are several near-universal goals, stated in the first person:

• I do not want to die tomorrow and leave my family destitute.
• I do not want to become seriously ill and leave my family destitute.
• I do not want to run out of money in retirement and become dependent on the state or my children.
• I do not want to become a financial burden on others if I need long-term care.
• I want to leave a legacy to my children, without it causing strife, or it being eroded by tax.

For most people around the world, it is hard enough to achieve the goals one to four listed above, however, for the remainder of this thought piece I would like to consider five, which is admittedly, for the privileged few.

The Wealth Transfer Dilemma

Most investor’s primary motivation for financial planning is to ensure they do not outlive their money. Disciplined investors, most of whom are supported by a competent and caring financial adviser, can, however, reach a position where it becomes clear that they will never spend all their money in their lifetime.

While this position is a luxury, it is well deserved and can be traced back to their decisions over multiple decades. Some investors can be convinced to increase their spending on activities and causes that bring them meaning, but many will still die with a sizeable net worth. They are driven by a desire
to leave a legacy to those they love, and their wealth becomes a river, which will flow to the next generation. Studies suggest that we will witness one of the most significant wealth transfers in history over the coming decades. This presents opportunities and challenges for families and raises important questions about how and when to pass on assets.

The Traditional Approach

For a long time, most families have defaulted to the conventional method of wealth transfer, leaving an inheritance after death.

This approach offers several advantages. It allows investors to maintain control of their assets throughout their lifetime, insuring against unforeseen setbacks or expenses. The extent and cost of future medical care are difficult to predict, and more wealth only means more freedom and opportunities.

However, this traditional model also comes with potential drawbacks. One significant concern is timing - your heirs may not need the money when they finally receive it, possibly being close to retirement themselves. By waiting until after your passing to transfer wealth, you miss the opportunity to witness and guide the impact of your generosity. There is something uniquely rewarding about seeing your hard-earned wealth make a difference in your loved one’s lives while you are still here.

Additionally, depending on your jurisdiction, there may be higher estate taxes compared to lifetime giving strategies, potentially reducing the amount your beneficiaries receive. The traditional inheritance model offers security and control, but it is important to weigh these benefits against the potential missed opportunities for impact and guidance.

The ‘Warm Hand’ Approach

An alternative to the traditional inheritance model is the ‘warm hand’ approach - giving while you are still alive. This strategy has gained popularity in recent years as more people recognise the potential benefits of transferring wealth during their lifetime.

One of the most significant advantages is the ability to witness the impact of your generosity firsthand. There is a unique joy in seeing how your financial support can change lives, whether helping a grandchild through university or giving your children a head-start with weddings, house purchases or business projects.

The ‘warm hand’ approach also allows you to provide guidance alongside your gifts. You can share your financial wisdom, helping recipients learn to manage and appreciate the wealth they are receiving.

However, this approach has its challenges. Giving away assets during your lifetime gives you less control over your wealth. You also risk jeopardising your financial security if you give away too much too soon. Ensuring you retain enough assets to support yourself through retirement and potential healthcare needs is crucial.

Many people start by using their annual donation tax exemptions, which can provide tax benefits while gradually transferring wealth, but it is also possible to transfer wealth during your lifetime by structuring it as a loan to the recipient. Contributing to education costs is another popular option, whether paying school fees or funding a university savings plan. Some choose to help with major life expenses, such as providing a down payment for a child’s first home.

Estate Duty and Donation Tax implications

Each approach has challenges to consider. One of those challenges is tax implications. Donations tax and Estate Duty are cleverly set at the same amount – 20% for the first R30 million and 25% thereafter.

Estate Duty

When you pass away, the first R3.5 million of your dutiable estate is exempt from estate duty. This, however, does not apply to your spouse. Anything left to a spouse is exempt from estate duty. A cleverly drafted Will could make use of both the spousal deduction and the R3.5 million abatement at the same time, or you can double the R3.5 million by creating a ‘rollover.’ The ‘rollover’ can only be created by leaving your entire estate to your spouse. By bequeathing your entire estate to your spouse, you won’t use your abatement which will then rollover to your spouse. Your spouse then receives the benefit of your abatement plus their own in his/her estate when they later pass away.

Donations Tax

Similarly, donations tax does not apply between spouses. You can donate any asset to your spouse during your lifetime and not incur donations tax. The difference with donations tax is that, if you are donating to anyone other than a spouse, then you have a maximum of R100 000, in total, exempted from donations tax per year (not per person you give to).

Loan Accounts

When you can structure your gift as a loan to the recipient, the loan is not a donation and therefore does not trigger donations tax. The unfortunate part is that if it is not repaid, then the loan account becomes an asset in your estate. You can write it off in your Will, but that is the point at which estate duty will become applicable on the loan account. However, the value of the loan is capped at what you gave.

The value of the loan account will reduce over time if repayments are made towards it. You can still follow the ‘warm hand’ approach by making a donation to the recipient which they can use to repay the loan. By keeping the donation under R100 000 per year you will not be liable for donations tax while at the same time reducing the value of your estate in respect of the loan account. There is the potential, under your, and your adviser’s wise guidance, for it to grow in the hands of your recipient. That growth will not form part of your estate.

• Scenario A – you leave R5 million to your child in your Will. The first R3.5 million is free from estate duty, but the remaining R1.5 million is taxed at 20% = R300 000.
• Scenario B – you give your child R5 million via a loan. Over 5 years, you apply your R100 000 donations allowance toward the repayment of the loan and bring the balance down to R4.5 million before passing. In your Will, you then write off this balance. R3.5 million is deducted from this and the remaining R1 million is taxed at 20% = R200 000.

Meanwhile, your child very cleverly invested the R5 million with your wealth transfer, and the market value of that investment when you pass away is R10 million. That R5 million growth is not in your hands but rather in the hands of your child. It therefore is not in your estate and not attracting capital gains tax, estate duty or executor fees. The only implication for you is the balance of the R5 million loan you gave via the ‘warm hand’ approach.

Let us use the same Scenario B, but this time, you have perfected your timing and managed to reduce the value of the loan over a period of 10 years down to R4 million. Deduct the R3.5 million again and the balance of R500 000 is taxed at 20% = R100 000. *All illustrations above are based on the assumption that the loan account is the only dutiable asset in your estate.

Crafting Your Strategy

Navigating the wealth transfer dilemma often involves not choosing one approach over the other but rather finding the right balance between lifetime giving and traditional inheritance. This balance will be unique to each individual and family based on a range of factors. As your financial advisers, we are here to help you understand your options, consider the implications, and create a personalised plan that aligns with your goals and values. By taking a thoughtful, balanced approach to wealth transfer, you can create a legacy that provides financial support to your loved ones and imparts your values and wisdom to future generations. It is a powerful way to ensure that your life’s work continues to have a positive impact long into the future.

Reminder

Continuing with the theme of ‘gift-giving,’ the ability to externalise money each year via either or both of your Single Discretionary Allowance (SDA) or Foreign Investment Allowance (FIA) might be construed as a ‘gift’ from the South African Reserve Bank (SARB).

There are many reasons often cited for externalising monies outside of South Africa. These include, but are not necessarily limited to the following:

• Diversification
• Valuation
• FX volatility
• Political risk

Thus, if your Portfolio has a large ‘home bias’ then this is a friendly reminder that should you be in the fortunate position to have any excess cash and where you may not have utilised either of your R1m p.a. SDA or your R10m p.a. FIA (the latter requires that you obtain an ‘Approval for International Transfer’ from SARS) then you might consider doing so before the 31st December 2024 - any unutilised allowances are lost and not carried forward into 2025.

As always, it is important to talk to your Wealth Manager about the relative suitability of externalising monies in light of your unique investment circumstances.