AN ESTATE DUTY CONUNDRUM

AN ESTATE DUTY CONUNDRUM

How to pay the estate duty when the estate is likely to have insufficient cash 

A common estate-planning technique to ensure that an estate has substantial fixed assets, but insufficient cash with which to pay all the estate duty due, is for the testator to establish a life policy to settle this estate duty. 

However, in order to prevent this policy from being taxed in the estate, and to avoid paying executor’s fees on the policy amount, the testator would nominate beneficiaries (e.g. spouse and children) to receive payment directly, rather than to make the proceeds payable into the estate. 

This raises the question of how the executor recovers some of these life policy proceeds back into the estate to settle the estate duty due. In answering this question, a few important factors need to be considered. 

The first point to make is that the executor of the estate is liable to pay any estate duty out of the assets of the estate. If those assets are insufficient, the executor will consult with the residuary heirs to establish whether the assets from the estate should be sold in order to generate cash, or whether the residuary heirs are prepared to contribute cash to cover the shortfall. If they are not prepared to pay in cash to cover the shortfall, the executor is obliged to sell assets to raise cash. If the sale of assets will cause great inconvenience to the heirs, for instance if the main asset is the house in which they live, the it is clearly in their interest to contribute to the shortfall in order to avoid a forced sale. 

Secondly, the testator needs to ensure that the policy beneficiary pays the estate duty liability directly to SARS and not into the estate, otherwise the executor will be entitled to their fee for dealing with the incoming cash. 

Thirdly, the testator should create a binding obligation on their beneficiary to use the policy proceeds to settle any shortfall. Without this, the beneficiary could decide to use the policy proceeds for another purpose. 

The general principle is that a contract entered into before death has to be respected by the executor and other party after death. So the testator and their spouse could enter into a binding written agreement that the spouse will use as much of the policy proceeds as necessary to settle the estate duty liability. This would not be regarded as a donation, because it is not made out of liberality and generosity, but as fulfilment of a contractual undertaking and in order to avoid a situation prejudicial to the heirs where assets are sold by way of a forced sale. 

Of course, the executor needs to be aware of such a contract, in order to enforce it, and it would be wise to attach a certified copy of it to the will which is held in safe custody in the executor’s vault. 

The complexities of making such an arrangement illustrate the need for comprehensive estate planning. By using accredited professionals for both the estate planning and the drafting of the will, the risk of encountering costly surprises can be minimised and the estate administration process can run smoothly. 

Reference: 

Clive Hill – Moneyweb’s Personal Finance