THE FINANCIAL WELLNESS COACH: Three effective strategies for passing wealth to your grandchildren

An inheritance can be structured in several ways, but tax, costs and control differ sharply.

Question: I have R10-million that I would like to use to provide my grandchildren with a passive income. What is the best way to structure this?

There are a few possible routes, and each has very different tax, cost and control implications. I will run through the pros and cons of a few options.

A family trust is often the first thing people think of when they want to leave money for children or grandchildren.

It can work very well when control and protection are important. The trust deed can set out what the money may be used for, and the trustees can pay school fees or university costs, or assist with a home, without simply handing over the capital. The grandchildren do not necessarily get unrestricted access to the money at a young age.

The downside is that trusts can be expensive with continuing legal, accounting and trustee costs. They are also taxed at high rates if income or gains are retained in them.

You also need to consider how the R10-million will be transferred into the trust. If you donate the money to the trust, donations tax may be payable. Alternatively, you could lend the money to the trust, but this brings additional tax and administration requirements, and the loan will need to be managed carefully over time.

Another option is to give the money to the grandchildren. The problem is that a large donation can be expensive. You can donate R150,000 per year without donations tax. Amounts above the exemption are generally taxed at 20% until cumulative taxable donations reach R30-million, after which a 25% rate applies.

If you gave away the full R10-million in one year, that would trigger about R1.97-million in donations tax.

You could make use of the annual exemption and donate R150,000 each year. A spouse has a separate annual exemption, so the family could potentially move R300,000 a year without donations tax. This is useful for education costs or annual support, but it is a slow way of transferring R10-million.

If you are already 55, another option is to contribute some or all of the money to a retirement annuity (RA) and then retire from the fund into a living annuity.

There is an important tax advantage to doing this. Your deduction for retirement fund contributions is limited to 27.5% of the higher of your qualifying remuneration or taxable income, subject to an annual maximum of R430,000.

If you contribute more than you are allowed to deduct in that year, however, the excess is not lost. It is carried forward and can potentially be used in future years. These amounts are commonly referred to as disallowed contributions.

Once you retire and transfer the money to a living annuity, the disallowed contributions that have not previously been used can be set off against your annuity income. This means that your living annuity income can be tax-free in your hands until those unused contributions have been exhausted.