Understanding Death Benefits in Retirement Plans

Have you thought about what happens to your retirement savings once you’re gone? These assets don’t simply disappear; they act as vital financial support for your loved ones. The distribution of these funds varies depending on the type of retirement product you possess. Pension and provident funds, retirement annuities, preservation funds, and living annuities each have distinct processes regarding their death benefits.

Living annuities: Quick and simple

A living annuity provides income drawn from your retirement savings after you retire. You have the power to decide on your annual withdrawal amount (between 2.5% and 17.5% of your investment value). This financial tool operates under the Long-Term Insurance Act and the Income Tax Act.

Upon your passing, the beneficiaries specified in your annuity contract will inherit the remaining investment.

• You can change your beneficiaries whenever you wish. If you neglect to do so, such as after a divorce, the designated beneficiary will still receive the benefit since the insurer cannot modify your choice.
• If no beneficiaries are designated, the benefit will go to your estate and may be subject to tax.
• Living annuities are not regulated by Section 37C of the Pension Funds Act, meaning trustees have no involvement. This results in a more efficient and predictable process, allowing beneficiaries to access benefits without waiting for estate finalization.

Retirement funds: The trustees’ role

Retirement funds, including employer pension and provident funds, preservation funds, and retirement annuities, have a different framework. These savings are governed by Section 37C of the Pension Funds Act, which mandates that trustees decide how your funds are to be distributed after your death.

This regulation is designed to protect your dependents, but it can mean that your preferences may not be followed strictly. For instance, if you have named an ex-spouse as a beneficiary but no longer support them, the trustees may determine not to grant them benefits.

How it works

• It’s crucial to complete a beneficiary nomination form, which informs trustees but isn’t legally binding.
• You can nominate dependents as well as others who may not be financially reliant on you.
• Retirement funds are not included in your estate and therefore cannot be distributed through your will.
• Your nomination form does not replace a will; a valid will is essential for distributing your other assets. Without one, the Intestate Succession Act will dictate distribution, potentially against your wishes.
• Some funds might offer an ‘Infund’ living annuity. As these remain within the retirement fund, trustees will still apply Section 37C for distribution decisions.

Factors considered by trustees

Trustees are responsible for identifying and assessing all potential beneficiaries before finalizing distributions. They take into account various factors, such as:

• Financial dependency, relationship dynamics, and ages of beneficiaries.
• Individuals you support financially, even if they are not officially recognized as dependents.
• The existence of second families, regardless of legal status or prior awareness.
• Adult children count as dependents but might not always receive a share of the benefits.

The trustees aim for equitable distribution, which may not directly align with your nomination form. For example, if you name your spouse as the sole beneficiary, trustees could choose to allocate some benefits to your minor children. In such cases, the children’s benefits are typically placed (post-tax) into a beneficiary fund or trust, ensuring funds are available for their everyday needs until they reach adulthood.

This process can take a significant amount of time, lasting up to a year, due to the trustees’ obligation to thoroughly review and confirm all dependents before making a final decision. No distributions occur until this process is complete.

Beneficiary options

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• As a cash payout (post-tax);
• By rolling it into their own living annuity (with no upfront tax deduction); or
• A combination of both.

This flexibility allows beneficiaries to customize their inheritance according to their financial needs.

Any cash disbursed is taxed under the deceased’s name, following the retirement lump-sum tax tables (as opposed to income tax rates). Tax will be applied proportionately according to each beneficiary’s share.

Understanding the regulations surrounding different products empowers families to prepare, manage expectations, and make informed choices.

To protect your loved ones:

• Always keep your beneficiary nomination forms updated.
• Ensure you use the correct format required by your living annuity provider.
• Revisit your beneficiaries after major life events like marriage, divorce, or the birth of children.
• Maintain a current will to cover your other assets.

Taking these steps helps ensure that your family avoids uncertainty or financial strain during an already difficult time. Consult with a financial advisor for guidance on effectively structuring your estate to best support your beneficiaries.

Rita Cool ‒ Head of Retail Best Practice at Alexforbes.

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