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What is a beneficiary fund and why should I care?

Article provided by Fedgroup

Many financial experts who have spent years in the industry are surprised to learn that a financial product called a beneficiary fund exists. However, they perform a vital role in providing for the most vulnerable members in our society who have lost a breadwinner, and can also provide a valuable estate planning tool for everyone from low-income earners to high-net-worth individuals.

Beneficiary funds are unique to South Africa and were created by government to assist schoolgoing children to complete their education should a breadwinner pass away. Contrary to what many believe, the money that is saved towards a pension or provident fund does not automatically form part of an estate after you die. Instead, the trustees of that fund are legally obliged to first decide whether to pay the money into the estate or to pay it into a beneficiary fund.

To make this decision, the trustees must investigate who the dependants of the deceased person was, and whether the remaining spouse or new guardian can look after the dependants’ financial needs. If they believe that money paid to this person could be squandered for any reason, including gambling, spiralling debt, addictions or even poor financial literacy, they would opt to pay the money into a beneficiary fund instead. This fund then makes regular payments to assist the children with food and schooling.

Trustees are also obliged to find all beneficiaries of a fund member who has passed away. Therefore, if a person remarried, for instance, a child with a first wife would also be considered a beneficiary, particularly if the deceased person made monthly child support payments. The trustees are therefore free to disregard any instructions in a Will that allocates pension or provident fund money to other recipients, although they would often use the person’s last wishes as a guideline.

Because the funds from a pension or preservation fund are taxed before they go into a beneficiary fund, no tax is accrues when money is paid out to beneficiaries, the same way that money in these funds are not taxed when the fund pays out after retirement. These funds are known as approved benefits.

In the past, beneficiary funds were not allowed to receive funds from unapproved benefits. These are benefits that accrued from free-standing, employer-owned death benefit policies, or retirement annuities that individuals own in their personal capacity. However, new legislation now also allows unapproved benefits to be paid into a beneficiary fund. Other benefits, such as life insurance, may be approved or unapproved, depending on the structure that is used. It is therefore beneficial in estate planning to find out what legislation applies to one’s benefits.

Because unapproved benefits form part of a deceased estate, one would have to explicitly state in one’s Will that the money in that fund is to be paid over into a beneficiary fund. This option is becoming increasingly popular because of the benefits offered by beneficiary funds.

Beneficiary funds are more tax efficient than traditional testamentary trusts because they are taxed in the same manner as pension funds. Once benefits, approved and unapproved, are paid into a beneficiary fund, the investment income is tax exempt and any payments out of a beneficiary fund (capital or income) is tax free.

These funds also provide better protection to benefits than trusts, as the legislation governing it has stricter controls and enforcement. In addition, surviving beneficiaries can now benefit from these funds almost immediately as policies of this nature are not subject to deliberation by a board of trustees, and payment is effected to the nominated beneficiary as soon as all administrative requirements have been met.

Testamentary trusts, on the other hand, do have a board of trustees. These are often family members who then gain control over the use of these funds. You would have to trust absolutely that they will apply these funds to the best possible benefit of your children.

The trustees have the ability to invest in whatever they choose. It might be a new business opportunity that has great upside potential, but also poses great risk.

These trusts also need to be audited. The trust then needs to pay the auditors for their work on just that one trust. In a beneficiary fund, the auditors do one audit on behalf of all the beneficiaries and the costs are shared. Your share of the costs therefore is far less than what you would pay to audit a specialist trust.

Many high-net-worth individuals who make provision for beneficiary funds in their Wills use a hybrid approach whereby some assets are allocated to a trust and some to the beneficiary fund. Assets such as a holiday home, for instance, may be managed better through a trust. Trusts also allow for a bit more flexibility. Therefore, a beneficiary fund can take care of the basics, such as schooling and clothes, while a testamentary trust can provide for additional lifestyle items such as an overseas holiday for the deceased’s children.

When the decision has been taken to pay money into a beneficiary fund, whether by trustees for approved benefits, or by individuals in their Wills for unapproved benefits, selecting the right beneficiary fund becomes the next crucial decision. Many providers offer beneficiary funds as add-on products under their pension fund banner. But applying the same approach to a beneficiary fund for minor children than you would for retired pensioners my not be in the beneficiaries’ best interest. It is therefore prudent to consider funds that follow a specialist approach.

Some funds process requests for payment from guardians without taking a long-term view, which means that beneficiaries may run out of money before they leave school. Some funds also only pay out a fixed monthly sum, while others allow for beneficiaries or their guardians to apply for ad-hoc payments, such as when a new laptop is needed. Some funds even offer cost-effective add-on benefits, such as medical assistance and educational support. Weighing up all of these factors will help to assess which beneficiary fund provider is best suited to meeting the needs of minor children.

Whether you are a parent concerned with estate planning or a trustee of a pension fund, taking time to consider the merits of beneficiary funds will assist in ensuring the best futures for those entrusted to your care.

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