case study

Case Study

M Botha

1

Background information.

You have recently interviewed Cameron and Margaret Wriothesley and obtained the following information from them.

Cameron (aged 52) and Margaret Wriothesley (aged 49) are married out of community of property. Accrual under the Matrimonial Property Act has been excluded by their ante-nuptial contract.

The couple have two children, a son David (aged 16), and a daughter Catherine (aged 23). Catherine is an editor with a community newspaper and lives with her parents. David is in grade 10 and will to go to university after he has matriculated. He will start his first year at the beginning of 2016 (taken as in exactly three years’ time). He will do a 4 (four) engineering degree. Cameron has established that David will need an amount of R80 000 per year (current value) for the duration of his 4 (four) year course. This amount must make provision for inflationary increases.

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Cameron was seriously injured three years ago when his motor boat collided with a fishing trawler in April 2010. He was not physically disabled but suffered from severe depression and retired in July 2011 (the rules of his pension fund allowed early retirement from age 50). At the time he regarded his pension benefit as substantial. He received the following benefits from the fund.

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(i) A total retirement benefit of R9.6 million (R9 600 000) of which he commuted one-third for a lump sum of R3.2 million (R3 200 000). The after-tax amount was used, partly to purchase 55% of the shareholding in a company in which both he and his wife are currently employed, and partly to make some investments. The investments made are included in the list of his assets which is provided below.

(ii) The remaining two-thirds of R6.4 million (R6 400 000) were used to acquire a “living annuity”. Since July 2011 he has taken the minimum drawdown amount of 2.5% per year. The value of the “living annuity” assets is currently R6.45 million (R6 450 000). He has nominated his wife, Margaret, as beneficiary to receive the benefit in the event of his death.

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(i) He donated R360 000 to Margaret and she invested it in a money market account in her own name. She earns interest of 6% per annum. The purpose of the donation was to provide Margaret with interest income so she could qualify for the interest exemption in terms of section 10(1) of the Income Tax Act (the current exemption is R23 800).

(ii) An amount of R600 000 was invested in a voluntary purchased annuity for a fixed period of 10 (ten) years. Cameron is the annuitant. The annuity is paid in monthly amounts of R7 929. The capital (tax-free) element of each monthly amount is R5 000. He has so far received 24 (twenty-four) of the total of 120 (one-hundred and-twenty) monthly annuity amounts payable under the contract.

The following investments were made from the after-tax lump sum that he received at retirement:

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(iii) He invested R460 000 in RSA Retail Savings Bonds (RSA RSB’s) at 9% per annum. Interest is paid semi-annually. The term is 5 years and commenced on 1 August 2011. The interest is paid out to him (not reinvested in RSA RSB’s).

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Their business interest and employment details

Cameron and Margaret are both employed by Wriothesley (Pty) Ltd, a company that manufactures steel gates and fences. The shareholders are the Cameron Wriothesley Family Trust, an inter vivos trust (founded by Cameron in 2011), and Margaret’s brother, Thomas Taylor. The trust owns 55% of the shareholding and Thomas owns the remaining 45%.

After the trust was formed Cameron sold his shares, consisting of 55% of the total shareholding in the company, to the trust. The purchase price was R800 000 and was paid by way of a loan account.

The loan is payable on demand, is interest free and has not been repaid. Margaret’s brother, Thomas Taylor, owns his shares in his personal capacity.

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The total value of all the issued shareholding (100%) in the company was recently valued at R3 500 000. The company has 150 authorised shares of R1 each of which only 100 have been issued. The Cameron Wriothesley Family Trust and Thomas Taylor have entered into a buy-and-sell agreement in terms of which the trust will purchase Thomas’ shares from his estate if Thomas is to die first. Thomas will purchase the shares owned by the trust if Cameron dies before him. It is a discretionary trust and Cameron, his wife and their children are the beneficiaries. Cameron is one of the three trustees of the trust. The agreement is funded by the following two life insurance policies:

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On Cameron’s life: This policy is owned by Thomas. It is a pure risk policy and the death claim value is R1 925 000. Thomas pays the monthly premium of R1 450.

On Thomas’s life: This policy is owned by the Cameron Wriothesley Family Trust. It is a pure risk policy. The death claim value is R1 575 000. The trust pays the monthly premium of R1 240.

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Asset Market Value

Base Cost

House in Rondebosch (primary residence) R3 200 000 R2 000 000 RSA Retail Savings Bonds R460 000 R460 000Loan - Wriothesley Family Trust R800 000 R800 000Assets in a living annuity account R6 450 000 Motor vehicle R250 000 R300 000Sundry personal use assets R250 000 R280 000

Cameron’s assets Cameron currently owns the following assets.

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Policy 1 A pure risk policy with a death claim value of R1 200 000. His wife is nominated as beneficiary. The monthly premium is R2 200 per month.

Policy 2 A pure risk policy with a death claim value of R1 575 000. His two children are nominated as beneficiaries in equal shares. The monthly premium is R1 800 per month.

He also owns life insurance policies on his own life. They are:

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Retirement fund interests

Cameron is a contributing member of a retirement annuity fund (RA). He plans to retire from his retirement annuity when he turns 60 (which is when he would actually like to retire if he can afford to so). He currently contributes R170 000 per annum to the RA. The current value of his interest in the fund is R350 000.

He is not a member of any other retirement fund. He regards the capital in the living annuity and the RA fund as his retirement capital. He is concerned about the fact that he is forced to withdraw 2.5% of the living annuity capital every year. He does not need to do so as his income from other sources are currently sufficient to cover their needs. To prevent the erosion of the living annuity capital he contributes the annual drawdown amount of R161 250 into his existing retirement annuity fund (it is included in the contribution of R170 000 which is mentioned above). He does not know the exact tax consequences this action.

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Outstanding bond on primary residence R494 858

Car loan R100 000

The outstanding term of his housing loan is 8 (eight) years. The interest rate payable is 8.5% per annum and his monthly instalment is R7 122. His last instalment will be due on his retirement date when he turns 60.

The interest rate on the car loan is 9.5% per annum and the remaining term is 2 years (24 months). His monthly instalment is R4 591.

Cameron’s liabilitiesCameron has the following liabilities:

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Assets Liabilities

Furniture and effects 350 000 Credit card 40 000

Motor car 190 000

Money market account 360 000

Collective investment scheme 335 000

R1 235 000 R40 000

Margaret’s assets and liabilities are as follows:

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(i) His employer contributes the full amount of the medical scheme membership of R3 600 per month. Cameron, Margaret and their son David are the members (three members).

(ii) His employer pays the monthly premium of an income protection policy for Cameron’s benefit. The monthly premium is R1 250. The policy was taken out on 1 March 2013.

Their income from employment is as follows:Cameron earns an annual salary of R780 000 (R65 000 per month). He receives the following other benefits from his employer:

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Margaret is employed as an administrative assistant at the same company and earns a salary of R20 000 per month. She receives no fringe benefits.

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Cameron’s monthly income and expenditure are as follows:

Income Payments

Cameron’s salary before tax 65 000

Annuity (voluntary) 7 929 Living annuity drawdown (R161 250 ÷ 12) 13 437 Interest on RSA Retail Savings Bonds 3 450 Instalment housing loan 7 122Car loan instalment 4 591Contribution to RA (R170 000 ÷ 12) 14 167Insurance premiums 4 000Income tax (estimated) 22 000Other (household expenses etc.) 25 000Surplus 12 936 89 816 89 816

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Note: Cameron specifically excluded Margaret’s income from the monthly cash flow as he does not want you to take it into account. Her employment with the company is temporary.

Cameron’s Last Will and TestamentCameron bequeaths the residue of his estate to his wife Margaret. No legacies are bequeathed to his children. Cameron and Margaret are happily married. They have gone through some difficult times together and he feels comfortable leaving his entire estate to her. He is aware that she will need most of the assets in his estate to provide her with an income for the rest of her life if he should die prematurely. At the same time he knows that she will preserve it for their children as far as she possibly can. Cameron’s parents are still alive and his father will leave his estate to Cameron’s children. Cameron’s main concern is thus to provide Margaret with sufficient capital in the event of his death. He also knows that she will attend fully to the needs of their minor son.

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Other personal information.

Cameron has fully recovered from the accident and has been given a clean bill of health by his physician during his recent annual medical check-up. He should not have a problem to obtain life insurance at normal rates.

Since his accident he has become very conservative in his investment outlook. He indicated that as he would like to retire at the age of 60 (in eight years’ time) and as he still has one child at school, he would not want to invest in any high risk investments. He has not given much attention to his “living annuity” investment portfolio and will need advice in that regard.

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1. Use the 2013/2014 tax tables in respect of any tax calculation

that you do.

2. Assume an inflation rate of 6% per annum.

3. In respect of any life insurance that you recommend on

Cameron’s life you must assume a premium of R14 per month

per R10 000 of sum insured.

4. Use the investment growth rates as given in each particular

question.

AnnexureAssumptions and rates to be used in answering this examination paper.

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Question 1

Calculate the amount of income tax for which Cameron is liable in the 2013/2014 year of assessment. Base your calculations on the facts as they are thus ignoring any recommendations that you may make at a later point. Show all your calculations.

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Answer to question 1

Salary 780 000Fringe benefits

- Medical scheme contributions 43 200- Income protection policy premium 15 000

Living annuity drawdown 161 250Annuity (voluntary) (R7 929 12) 95 148Interest RSA Retail Bonds 41 400Deemed interest (donation) 21 600Gross Income 1 157 598

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Gross Income 1 157 598Less: Exemptions Capital element annuity 60 000 Interest 23 800 83 800 1 073 798Less: Income protection premium 15 000

RA contribution 158 819 173 819 899 979Less: Medical [43 200 – 4(7 752) – 0.075(899 979)] 0Taxable income 899 979 Tax on R899 979 289 756Less: Rebate 12 088Tax payable 277 668

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Maximum RA contribution is 15% of (1 073 798 – 15 000). Therefore R158 819.

Monthly tax is R277 688 ÷ 12 = R23 139

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Question 2

Take into account that Cameron has nominated his wife Margaret as beneficiary of the living annuity and assume that the retirement annuity benefits will also be paid to her on Cameron’s death.

Calculate the amount of tax that will be payable on the retirement fund lump sum benefits on Cameron’s death if the living annuity as well as the retirement annuity benefits are taken as full lump sums (both commuted in full). Mention as to who the person is that will be liable for the tax.

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Answer to question 2 RA lump sum 350 000Commuted living annuity 6 450 000Plus: Prior RFLB 3 200 000 10 000 000 Tax on R10 000 000 (2014 RFLB table) 3 401 550Less: Tax on Prior RFLB of R3 200 000 953 550Tax payable 2 448 000 The estate liable but can recover the tax from Margaret.

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Question 3

Cameron was informed by the insurer that if he should commute the voluntary annuity today (during his lifetime) he will be paid a lump sum of R504 763.

Assume that his marginal rate is 40%. Calculate the after-tax amount that will remain in respect of the commutation amount if he should decide to commute the annuity today.

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Answer to Question 3 Commutation amount 504 763Less: Capital element (exempt) [R600 000 – (24 × 5 000)] 480 000 24 763 Tax = 40% of R24 763 = R9 905 The remaining amount after tax is R494 858 (R504 763 – R9 905).

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Question 4

Cameron is aware of the fact that as he bequeaths the residue of his estate to his wife there will not be any estate duty payable on his death. He wants you to calculate the total expenses that will be payable by his estate in the event of his death.

For the purpose of this calculation you must assume that the voluntary annuity was commuted during his lifetime to redeem the bond so that at the date of death the annuity and the housing loan can both be ignored. Also assume that administration expenses (excluding executor’s remuneration, but including the Master’s fees) are R10 000 and that funeral expenses are R30 000. Assume that Margaret is nominated as beneficiary of the living annuity.

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House in Rondebosch (primary residence) 3 200 000RSA Retail Bonds 460 000Loan owed to him by Wriothesley Family Trust 800 000Motor vehicle 250 000Sundry personal use assets 250 000 4 960 000

Answer to question 4The following assets will attract executor’s remuneration

Executor’s remuneration 3.99% of R4 960 000 197 904Admin fees 10 000Funeral expenses 30 000CGT (roll-over) 0Total costs 237 904

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Capital needed 1 P/YR Begin mode 420 000 PMT 34 N 1.88679 I/YR (8 – 6 = 2) then 2 ÷ 1.06 = 1.88679PV R10 667 465

Question 5Margaret has a life expectancy of 34 years. Cameron would like her to have enough capital to enable her to have an income of R420 000 per annum after his death. Her income must increase by the inflation rate of 6% per annum. Assume that the growth rate of assets that are invested after her husband’s death is 8% per annum. Calculate the capital amount needed by her.Answer to Question 5

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Question 6

Calculate whether she will have enough capital to provide her with the income needed as calculated in the previous question. Assets that cannot be used for this purpose must be disregarded. Assume that the voluntary annuity has been used to redeem the bond. Her own assets, inheritance and capital that she may receive from other sources must be taken into account.

Calculate the monthly premium of any life insurance that you recommend in the event of a shortfall.

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Capital available RSA Retail Bonds 460 000Loan Wriothesley Family Trust 800 000 1 260 000Less: Liabilities – Car loan 100 000

Estate expenses and funeral 237 904 337 904 922 096Plus: Living annuity (not commuted) 6 450 000

Life insurance payable to her 1 200 000RA (assumed taken as living annuity) 350 000Money market (own asset) 360 000CIS (own asset) 335 000

9 617 096Less: Own liabilities 40 000Capital available 9 577 096

Answer to Question 6

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Shortfall = R10 667 465 minus R9 577 096= R1 090 369

The policy will not attract estate duty as it will be deductible as part of the residue if it is made payable to the estate.

If made payable to the estate it will attract executor’s fee. To prevent that it is recommended that his spouse be nominated as beneficiary.

Premium is

R1 090 369 ÷ 10 000 14 = R1 526 per month

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Question 7

Cameron wants to know whether he should continue to contribute the minimum drawdown amount that he receives from the living annuity to a retirement annuity fund. Advise him on what to do. Give reasons for your answer.


Cameron currently contributes R170 000 to an RA fund. His maximum deduction is R158 819.

This ensures that he is not taxed on the living annuity drawdown amount.

Discussion: Is a living annuity drawdown income from “trade” as required by section 11?

Discussion: As from 2015 tax year he can deduct the RA contribution from “compulsory annuity” as exemption.

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Question 8

Cameron wants to know what the two different methods are that he can use to leave the “living annuity” benefits to his spouse after his death. Discuss the income tax, estate duty and executor’s fee implications in respect of each of these two options.

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Option 1.

He can nominate his wife as beneficiary to receive the benefit.

•Income tax. She will have the option to commute the annuity for a lump sum, or to continue with the annuity, or a combination of the two. No lump sum tax will be payable in respect of a portion of the benefit that is not commuted.

•Executor’s fee. No executor’s fees are payable if a beneficiary is nominated.

•Estate duty. The benefit is free of estate duty.

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Option 2.

He can choose not to nominate a beneficiary.

•Income tax. The benefits will be paid to his estate - his heirs will inherit the benefits. As she inherits the residue of his estate the living annuity benefits will also go to her (included in residue). Income tax will then be payable on the lump sum benefit.

•Executor’s fee. Executor’s fees will be paid on the benefits.

•Estate duty. There will be no estate duty but her heirs will not be in a position to pass the benefits estate duty free to their heirs when they die.

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Question 9

Refer to question 8. Advise Cameron as to which of the options that you mentioned would be the most income tax efficient for his beneficiary taking Cameron’s circumstances into account. Give reasons for your answer.


His beneficiary should not commute the annuity.

As Cameron is already in the 36% lump sum tax bracket as a result of his prior retirement lump sum benefit, the commuted amount will be taxed at 36%.

If the beneficiary continues with the annuity the rate of income tax payable on the drawdown amounts should be lower taking into account the annuitant’s tax threshold and the progressive rates of tax.

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Question 10

Advise Cameron as to who is liable for income tax on the interest that Margaret earns on the money that he donated to Margaret. Inform Cameron of the disclosure/reporting obligations that may be on (i) Cameron, and (ii) Margaret, in respect of such interest.


Cameron is liable under section 7(2) of the Income Tax Act.

Section 7(10) provides that any resident who, at any time during any year of assessment makes any donation, settlement or other disposition as contemplated in this section, shall disclose such fact to the Commissioner in writing when submitting his return of income for such year and at the same time furnish such information as may be required by the Commissioner for the purposes of this section.

Section 68 provides that such income must be included in the returns of the donor spouse.

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Question 11

Advise Cameron on how he can reduce his estate executor’s remuneration in the event of his death. Calculate the amount that will be saved if your recommendation is implemented.


He can nominate his wife as beneficiary in respect of the RSA retail bonds.

This will save R18 354 in executor’s remuneration (0.0399 of R460 000).

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Question 12

Cameron says he has been advised to bequeath the loan that the trust owes him to the trust. He has, however, heard that this could lead to adverse tax consequences. Advise him with reference to recent High Court judgments and legislation.


It could previously be seen as the discharge of a debt for no consideration under paragraph 12(5) of the Eighth Schedule to the Income Tax Act ( ITC 1793). The trust would have been seen to have disposed of the amount of the loan for a proceeds equal to such amount and the base cost would have been be deemed to be nil.

Paragraph 12(5) has been repealed with effect from 1 January 2013.

Discussion: New paragraph 12A of Eight Schedule.

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Question 13

13.1

In order to have the required amount of capital needed at his retirement date, his existing retirement capital (provided no drawdowns are made) will have to grow at a rate of 3% per annum above inflation between today and his retirement date. Take inflation as 6% per annum over the period.

Advise Cameron as to what factors are to be taken into account in putting together such a portfolio.

Answer to Question 13.1

•Cameron’s risk profile

•The term of the investment

•His investment objective

•The required return.

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13.2 Advise Cameron as to the various assets classes to which he must expose such a portfolio and indicate the percentages to be invested in each asset class.

Answer to 13.2Money Market 40 to 60%Bonds 15 to 35%Equities 15 to 35%Property 5 to 20%

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Question 14

Cameron wants to know whether the policy that Thomas Taylor owns on Cameron’s life will be subject to estate duty if it was not for the fact that Cameron leaves his entire estate to his wife. Advise him and give reasons for your answer.


Yes it is be deemed to be property in Cameron’s estate. It is currently not dutiable as it is negated by the Section 4A abatement of R3 500 000.

It is not excluded by sec 3(3)(a)(iA) of the Estate Duty Act as Cameron (life insured) and Thomas do not both own shares in the company (the trust has bought Cameron’s shares).

Discussion: Estate duty in respect of life insurance and apportionment.

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Current cost is R80 000 per annum.Cost in first year (in three years’ time)Begin mode 80 000 PV 3 N 6 I/YR FV 95 281

Question 15Cameron wants to contribute monthly instalments to a collective investment scheme for a period of 3 (three) years. His objective is to have sufficient capital in the fund at the end of the 3 year period to pay for David’s 4 (four) year course at university. Take the annual rate of inflation to be 6% per annum and that he can get a return of 8% per annum.Answer to question 15

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Then 1 P/YR Begin mode 95 281 PMT 4 N 1.88679 I/YR (8 – 6 = 2) then 2 ÷ 1.06 = 1.88679 PV R370 667

12 P/YR Begin mode 370 667 FV 3 Shift N 8 I/YR PMT R9 084

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Question 16

Take your recommendations into account and draw up a new monthly cash flow to show whether Cameron can afford the premiums/contributions that you have recommended.

You do not have to recalculate his income tax payable for the purpose of answering this question.

Use the estimated amount of R22 000 per month as given.

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Question 17

Inform Cameron of three financial planning aspects in his estate that has not been addressed and that should be considered during their next planned meeting?


•Disability insurance

•Income protection insurance.

•Dread disease insurance.

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Question 18

Cameron wants to know whether he should commute the voluntary annuity in order to redeem his housing loan of R494 858, or whether it is better not to commute the annuity for this purpose. Show your calculations and advise him as to which one of the two options is the best.

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Annuity (monthly) 7 929Less: Capital element 5 000Taxable portion annuity (monthly) 2 929


The after-tax lump sum that he will receive if he commutes the voluntary annuity is R494 858. That is also the outstanding value of his loan.

The rate of interest on his bond is 8,5%. He must therefore earn an after-tax rate of more than 8,5% on the annuity in order not to repay the bond.

The after-tax rate of the annuity

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Tax on annuity (monthly) = R2 929 40% = R1 171.60 After-tax annuity = R7 929 – R1 171.60 = R6 757.40

END Mode 12 P/YR 494 858 +/- PV6 757.40 PMT8 Shift NI/YR 7.04%

The after-tax return that he gets on the current capital value (if commuted) of the annuity is:

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It is less than the 8.5% that he pays on the bond.

He should commute the annuity to redeem the bond.

Note: An alternative answer is that the after-tax annuity is R6 757.40 which is smaller than the bond instalment of R7 122. If he continues with the annuity he will have to continue to pay the difference of R364.60 per month out of pocket. If he commutes the annuity he can redeem the bond and save R364.60 per month.

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Question 19Cameron will soon appear on the new local TV series Dragons Den where he will apply for an investment in return for a one-third share of the company.How should such a deal be structured. Give two options.

Answer to question 19•Option 1: Sell one-third of each of the current shareholder’s shares.•Option 2: Issue the remaining 50 authorised shares.

The latter best.

Discussion: Shareholding - new Companies Act.

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Question 20What is the amount that the Dragons will have to invest for a one-third share in the company? Answer to question 20Two-thirds = R3 500 000Therefore one-third = R1 750 000

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Question 21

Discuss an alternative method for the sale of the shares of a deceased shareholder.


Discussion share buy-back.

Thank you

End

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case study

Documents

margaret wriothesley

monthly annuity

living annuity assets

interviewed cameron

following investments

years time

year current value

pension benefit