Use Your Pension for Better Estate Planning

Most people think of their retirement fund as a retirement tool and nothing more. Contributions go off every month, the statement gets filed away, and the whole thing only really becomes interesting somewhere around 60. But your pension fund, provident fund, preservation fund and retirement annuity are quietly some of the most powerful estate planning instruments available to a South African investor. And the best part is that you don't have to give anything up to use them that way.

That's unusual, estate planning normally involves a trade-off. You move an asset into a trust and lose direct control. You wrap something in a structure and accept a cost. You buy a policy and pay a premium. Here you don't trade anything. You keep investing, you keep growing, and the estate planning benefit simply comes along for the ride.

So what happens to your retirement fund when you pass away?

If you die before retiring from the fund, the benefit is governed by section 37C of the Pension Funds Act. This is one of the most misunderstood provisions in South African law, and it does something quite remarkable: the money does not form part of your estate. It is not distributed according to your will. It is not governed by the Intestate Succession Act if you die without one. It sits entirely outside the normal machinery of deceased estate administration.

Practically, that means three things:

• Estate duty: The benefit is excluded from your property for estate duty purposes under the Estate Duty Act. No 20% on the portion of the dutiable estate between R3.5 million and R30 million. No 25% above R30 million. Nothing.

• Executor's fees: Because the capital never enters the estate, it never forms part of the base on which executor's fees are calculated. The general tariff is 3.5% plus VAT — roughly 4%. On R5 million, that's R200 000 you simply don't pay.

• Liquidity: Your family doesn't wait for the Master of the High Court to accept the Liquidation and Distribution account. In practice, estates take anywhere from nine months to two years. Retirement fund benefits move far faster than that.

And then there's the growth itself. Inside a pension, provident, preservation or retirement annuity fund, there is no income tax, no dividends tax and no capital gains tax on the growth. You can switch between funds and rebalance the portfolio without triggering a single CGT event.

Compare that to a discretionary unit trust, where interest above your annual exemption is taxed at your marginal rate, dividends attract 20% dividends tax, and every switch is a disposal for CGT purposes. Over twenty years that difference is not small.

There is one catch before retirement.

Section 37C gives the fund's board of trustees the discretion to decide who receives the benefit. Your beneficiary nomination form is a guide, not an instruction. The trustees must identify your dependants — legal, factual and future potential — and distribute the benefit in a manner they consider fair and equitable. They can and do deviate from nomination forms.

For most families this works out fine, because the people you would have nominated are usually your dependants anyway. But it does mean that while you are still a member of the fund, you don't have final say. Which brings us to the part that most investors don't know about.

The Pension Funds Act lets you retire from age 55.

From 55 you can retire from a retirement annuity or preservation fund. Not from your job — from the fund. You can still be working, still earning, still contributing elsewhere. This is a product decision, not a life decision, and the two get confused far too often.

When you do, up to one third can be taken as a cash lump sum. The first R550 000 of retirement lump sums across your lifetime is tax-free, though prior withdrawals — including two-pot savings component withdrawals since September 2024 — reduce what's left of that allowance.

The balance buys an annuity, and for planning purposes that generally means a living annuity, from which you can draw between 2.5% and 17.5% of the value each year.

Now look at what that living annuity does for your estate plan. The capital remains outside your dutiable estate. Your nominated beneficiaries are paid directly by the product provider, so no executor's fees are charged on it. And critically, unlike the pre-retirement funds, there are no trustees exercising discretion. Your nomination is binding, and you can nominate anyone — a spouse, a child, a grandchild, a sibling — without them having to prove financial dependence on you.

Your beneficiaries also get to choose how they receive it. They can take the full value as a lump sum, taxed on the retirement lump sum table in your name. They can continue the annuity in their own name and draw a monthly income, taxed at their own marginal rates. Or they can do a bit of both. For a surviving spouse with thirty years ahead of them, the ability to simply continue drawing an income — starting almost immediately, without waiting on the estate — is often worth more than the tax saving.

What about liquidity while you're alive?

This is where the "retire at 55" option quietly solves the problem people worry about most. The usual objection to putting money into retirement structures is that it gets locked away. That objection largely disappears after 55. You have access to a lump sum, and you have an income stream you can adjust annually within the drawdown band. If you hold several retirement annuities, you can retire from them in tranches rather than all at once, which gives you even more control over timing and tax.

So liquidity is not really the constraint that people assume it to be.

Which brings me to how I use this with clients.

If a client has both discretionary investments and compulsory investments, and the ratio between them allows for it, I will often let them draw a larger portion of their income from the discretionary side. It seems counterintuitive. But the discretionary money is the money that will attract estate duty and executor's fees and by drawing more from post-tax capital, you can also reduce income tax paid from living annuity income payments. So we spend the estate-unfriendly capital first and preserve the estate-friendly capital for the people who come after.

It is not a blanket rule. Selling discretionary units may trigger CGT, discretionary capital gives flexibility that a living annuity can't, and drawing it down too aggressively creates its own problems. The ratio has to support it. But where it does, the same income can be drawn in a way that quietly reduces what your family eventually loses to fees and estate duty.

What should you actually check?

Look at your beneficiary nomination forms. They are frequently a decade out of date, they often still name an ex-spouse, and on a living annuity in particular there is no trustee to correct the error for you. Then look at whether the split between your discretionary and compulsory investments is doing any work for you.

Good estate planning isn't about giving things up while you're alive so that someone else benefits when you're not. Done properly, it's about making sure the money you're already investing is sitting in the right place when it needs to move.

Reach out to me at ruvan@bovest.co.za to look at how your retirement structures fit into your broader estate plan.

Ruvan J Grobler FSA® (PGDip Financial Planning)