Beneficiary funds – what planners should know

Beneficiary funds were introduced in January 2009, yet many pension fund trustees and financial advisers remain unaware or confused about their use and advantages. Fairheads Benefit Services believes that all financial advisers, especially those who advise on employer sponsored group life policies, should be aware of this important fiduciary service and investment product.

What is a beneficiary fund?

A beneficiary fund is defined as a pension fund organisation in the Pension Funds Act No.24 of 1956 of South Africa. They were designed to accept and administer lump sum death benefits allocated in their discretion by pension fund trustees to the minor dependants of deceased pension fund members, as set out in section 37C of the Act.

Minor children stand a better chance of completing their education if their assets are managed in the beneficiary fund vehicle which is protected and governed under the Pension Funds Act and overseen by a board of trustees.

Employment related unapproved benefits

Since 28 February 2014, with further changes to the Act, beneficiary funds can now receive additional employment benefits - unapproved benefits in addition to approved benefits, as long as they are employment-related.

Many companies have a group life policy, accident cover or other risk benefit cover with a service provider that is separate from the company’s retirement fund. These are called unapproved benefits whereas the fund credit from the retirement fund is called an approved benefit.

Planners need to know that in the event of the death of an employee, the benefit accruing from an employer sponsored group life policy can also be paid to a beneficiary fund.

What are the advantages?

Advantages of beneficiary funds are that they are cost effective and tax effective, and offer institutional investment returns.

Beneficiary funds are taxed in the same manner as pension funds in South Africa, that is no tax is paid in the fund. Furthermore any payment out of a beneficiary fund, whether capital or income, is tax free.

In Budget 2014, the tax-free threshold for pre-retirement lump-sum benefits (including death benefits) was increased from R315 000 to R500 000. This was good news in particular for the families of blue-collar workers as raising the tax-free limit has ensured a relatively larger payout to dependants on their death.

Although some beneficiary fund accounts run into millions of rands, the average size is around R100 000 which, if carefully managed, can provide a monthly income and finance a child’s entire education through to tertiary level. When the member turns 18, the account is terminated and the funds paid out unless the member requests they remain in the beneficiary fund. See the graph below which illustrates how a relatively small investment of R100 000 can be stretched over a period of 13 years to provide for the education and well-being of the minor child, as well as preserving capital for a lump-sum payout of around R115 000 on termination.

(Note that at the consent/request of the member (the child who has just turned 18) the fund can retain the assets for continued growth until such time that the member instructs the funds to be released. This may assist the member to preserve their intended benefits where they may be getting family pressure for money, or do not feel comfortable at that stage in their life to be receiving a large cash payment.)

Beneficiary funds - a practical example

The graph illustrates an example of a member, aged five years at inception, with an original capital investment of R100 000. The funds are invested according to the board approved asset allocation model and payments from the fund include:

• Regular income payments to the guardian until the child reaches the age of majority
• Annual capital payments for education related expenses
• All fund costs
• A final termination benefit of approximately R115 000 payable in a lump sum to the member upon reaching the age of majority.

Note: The above example is based on Fairheads Umbrella Beneficiary Fund’s approved asset allocation model which is reblended annually. Historical investment returns have been used to project future investment returns (money market 12 month performance, income fund 36 month performance, stable funds 36 month performance and balanced fund 60 months performance). The example includes annual capital payments equivalent to 5% of capital introduced, income payments of 5% of capital introduced (paid monthly) and includes all fees and charges.

What should clients know?

As an adviser, you should let your client know about beneficiary funds. The HR departments of employer companies and fund trustees alike need to know about their advantages; they should also educate fund members who should be given the option of including them on their nomination form for trustees to consider their use in the event of their death.

Keith Dorman, an independent financial adviser with Dorman & Associates in Cape Town, says that advisers can play a key role in educating clients and trustees about beneficiary funds. “All planners have clients with employee benefits. If the client dies, how are you as an adviser going to ensure the family’s best interests are taken care of? A beneficiary fund for the kids’ education may take welcome pressure off the surviving spouse.

“It is important to note that beneficiary funds are not just for the lower income employee. Higher earners who are financially savvy are likely to appreciate the tax advantages afforded by a beneficiary fund.

“Planners should do their homework and choose the right beneficiary fund as service levels and costs can vary,” says Mr Dorman, referring to a recent Comparison Rates model developed by Fairheads Benefit Serivces to facilitate comparison among service providers.

A last word on umbrella trusts

Umbrella trusts are the predecessor vehicle to the beneficiary fund. They used to receive section 37C death benefits prior to beneficiary funds and most unapproved benefits up until 28 February 2014. Advisers should bear in mind that the umbrella trust still exists and remains a useful tool for estate planning as it can be mentioned in a client’s Will as an alternative to a more expensive testamentary trust.