Question:
Do you pay tax on a death benefit lump sum if it goes into a guaranteed income plan? My husband passed away and his death in service benefit is now payable to me. I know that if it goes into a living annuity it will not be taxed, what happens if it goes into a guaranteed income annuity? Will it still be taxed, and how tax efficient is such an annuity?
Answer:
Joan,
You (or rather your late husband) only pay tax on any cash lump sum you elect to receive. Amounts transferred to either a living or a guaranteed annuity are not taxed. You are then only taxed on the annuity income you receive.
As to the tax efficiency of a guaranteed annuity, that depends on the amounts involved and your current marginal tax rate. Say the death benefit was worth R1m. Assuming your late husband did not previously withdraw from a retirement fund, and you elected to take the cash. you would forfeit tax of R161 550 on this amount. If you invested some of the balance in shares, you would incur withholding tax on dividends. You would also pay income tax on interest income beyond the R23 800 exemption (provided you breached the tax threshold).
Now assume you use R1m to buy an annuity instead. Say you are 60 and you buy an inflation-linked annuity. You would receive an annual annuity of about R54 000 (R4 500 per month). This falls below the tax threshold, so you would receive the entire amount tax-free. However, if you received other income (eg if you are still working) then your annuity would be taxed at your marginal tax.
If you are torn between buying a living annuity or a guaranteed annuity, then tax will not be the issue as the annuity income from both is taxed in the same way. The issues that become more critical then are whether you want the safety of a guaranteed annuity (protecting you against longevity and investment risk, but locking you into a defined income for the rest of your life) or the flexibility of a living annuity (allowing you to make your own investment decisions and choosing your draw-down rate, within regulatory limits, but assuming investment and longevity risk in the process).
