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USING USUFRUCTS FOR ESTATE PLANNING (Richer Life 1 November 2004)

As Benjamin Franklin quipped, there are only two certainties in life – death and taxes. In estate planning these twin perils come together in the form of "death taxes" (more commonly referred to as "estate duty" by our friends at the SARS). Many South Africans don't give much thought to estate duty, some even unaware that a tax of 20% will be levied on their assets (above the threshold) upon their death. This is a travesty as a few hours of skilled estate planning can often reduce estate duty to nil, in a perfectly legal and acceptable manner.

Summary estate planning info

The most common form of estate planning revolves around reducing the value of an individual’s estate by making use of inter vivos trusts, interest free loans and donation planning. A less common, but more difficult strategy, makes use of the R 1.5 million abatement that every individual is entitled to in terms of estate duty payable upon death. By using both the husband’s and wife’s abatements a family can effectively transfer R 3 million worth of assets to their heirs duty-free.

In practice this is not always easy to achieve. This is because one can never be certain who will pass away first – husband or wife. In terms of income tax legislation, donations between spouses are free of any duty, so the obvious way to get around this uncertainty is to split the assets of their combined estate by way of donation between husband and wife. But here again we encounter practical problems, as the recent property boom in South Africa has ensured that many elderly resident’s major asset is their home. In most cases the property is registered in one of the spouse’s names so how does one split this principal asset? One could re-register the title deeds so that both husband and wife own 50% of the property each, but this would be subject to transfer duty and the high costs thereof are often prohibitive. What is needed is another less costly way to “split” the value of the property. Enter usufructs.

A usufruct grants the holder the right of use of the property for the rest of their life (or a defined period) but not ownership. The ownership still resides with the original owner and their portion is now known as the bare dominium. Although a usufruct has to be registered at the deeds office too, there is no transfer duty, so all that is payable is the conveyancer’s administration fee. This fee should not be more than about R 3000, which is substantially less than the transfer fees of R 200 000 plus on a property worth R 2.8 million. Due to the low cost it is also a lot easier to reverse a usufruct if personal circumstances or legislation changes.

The actual mechanics of how the usufruct reduces estate duty is rather complicated so the best way to illustrate it is by way of an example. Let’s assume a family where the husband is 73 and wife 65. They are married by antenuptual contract and have a grown son of 40 years old and daughter age 38. The home property is registered in the husband’s name and worth R 2.8 million. This makes up the bulk of the couple’s assets, with the only other substantial asset being the husband’s living annuity valued at R 1 million. We will now assume two plans, one in which no estate planning has been undertaken and plan two in which usufructs have been used in estate planning. This second plan is the writer’s creation, but has been vetted by both a Cape Town property attorney and leading estate planning experts in Johannesburg. In both plan one and plan two, the scenarios of both the wife and husband dying first will be considered.

PLAN ONE
At present the husband’s will leaves everything to the wife and the wife’s will, everything to the husband. This is how the vast majority of the wills in this country are structured. Lets look at what happens upon death.

Husband dies first

Property of R 2.8m plus assets of R 1m passes to wife. No estate duty as spouses.

Wife dies a year later. Estate duty = (R 3.8m – R 1.5m abatement) x 20%
= R 460 000

Total estate duty paid after both deaths = R 460 000

Wife dies first

No Bequests
Husband dies a year later. Estate duty = (R 3.8m – R 1.5m) x 20% = R 460 000

Total estate duty paid after both deaths = R 460 000

PLAN TWO
In this plan, the couple follow the advice of a reputable financial advisor and do some thrifty estate planning making use of usufructs. The husband registers a usufruct over the property as follows:

· The usufruct will allow the wife immediate use of the property until her death.
· Upon the wife’s death, the usufruct will pass to the eldest son for a period of one year.
· Upon completion of the one year, the usufruct will pass to the family inter vivos trust for perpetuity.

The husband leaves everything in his will to the family trust.

Husband dies first
The bare dominium is valued as follows in the husband’s estate:
Market value less usufruct value (see below)
= (R 2.8 m – R 2 298 780)
= R 501 220
The bare dominion plus R 1 million assets passes to the family trust.
Estate duty = (R 1 501 220 – R 1.5m) x 20%
= R 244.00

VALUATION OF USUFRUCT
= Market value x 12% x life expectancy of usufructuary (wife) discounted at 12%
= (R 2.8 m x 12%) x 6.84161
= R 336 000 x 6.84161
= R 2 298 780

The wife dies a year later. Her estate is valued as follows:

The usufruct is now left to the son and is calculated the same way as above but based on a fixed term of 1 year.
= R 336 000 x 0.8929
= R 300 014.40

Total estate = R 300 014.40
Estate duty payable = nil (less than R 1.5 m)

Total estate duty paid after both deaths = R 244.00 (A saving of R 459 756 over plan one)

Wife dies first

Usufruct of R 300 014.40 left to son.
Estate duty = nil (less than 1.5 m)

Husband dies a year later.
Value of estate: bare dominium (as calculated above) + 1m assets
= R 501 220 + R 1m
= R 1 501 220
Estate duty = (R 1 501 220 – R 1 500 000) x 20%
= R 244.00

Total estate duty paid after both deaths = R 244.00 (A saving of R 459 756 over plan one)

In order to keep things as simple as possible, the above calculations do not assume any growth in asset values over the different periods. Motor vehicles and personal effects have also been excluded from the calculation. Capital Gains tax has also been left out, but our independent estate planning experts confirm that the full calculations show that this plan is advantageous from a CGT point of view too.

It can be very clearly seen that a little planning, with a little cost, can result in your heirs receiving huge savings in terms of estate duty. A complete plan like the one above would cost in the region of R 10 000 (including the usufruct and trust formation) and this would result in a saving of approximately R 460 000.

As with all estate planning a few caveats need to be mentioned. Firstly, if a financial institution holds a bond over your property – they are very unlikely to agree to the usufruct. You will need to settle your bond first. This should not pose a problem to most retired couples, who should hopefully have paid off their bonds by this stage.

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continued/... The second and less straightforward caveat is that the usufruct is often overlooked as a real right. Should the couple experience marital problems and wish to part ways, the wife (or husband) will keep the right. Which effectively means that they could boot the other spouse out of the property even though the other spouse was owner! One would imagine that most marriages that have survived into retirement are in pretty good shape, but matters of the heart are never as clear cut as matters of finance, so couples need to be aware of this potential pitfall.

One of the reasons that estate planning does not attract as much interest as it should is that estate duty ultimately does not affect the deceased. And the reason you probably haven’t heard about usufructs is because there are not a lot of people out there peddling them. The commission on a R 460 000 life policy is far more rewarding than a few hours of administration fees. So when it comes to usufructs, estate planners will need to get pro-active and request specific advice from their financial advisors. And, as the costs of estate duty are effectively borne by the heirs, it is in the heir’s interests to become pro-active too. Indeed, it can pay the heirs handsomely to instigate and bear the costs of the estate planning themselves, as there are few other investments of R 10 000 around that will net effective gains of R 450 000 with such a degree of certainty.comment

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