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Case Study

Case Study. M Botha. Background information. You have recently interviewed Cameron and Margaret Wriothesley and obtained the following information from them.

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Case Study

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  1. Case Study M Botha

  2. 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.

  3. 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.

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

  5. 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.

  6. 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:

  7. Cameron’s assets Cameron currently owns the following assets.

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

  9. 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.

  10. Cameron’s liabilities Cameron has the following liabilities:

  11. Margaret’s assets and liabilities are as follows:

  12. 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:

  13. 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.

  14. Cameron’s monthly income and expenditure are as follows:

  15. 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 Testament Cameron 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.

  16. 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.

  17. Annexure Assumptions and rates to be used in answering this examination paper.

  18. 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.

  19. 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.

  20. 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.

  21. 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.

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

  23. Question 5 Margaret 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

  24. 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.

  25. Answer to Question 6

  26. 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

  27. 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. Answer to question 7 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.

  28. 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.

  29. Answer to question 8 • 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.

  30. 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.

  31. 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. Answer to question 9 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.

  32. 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. Answer to question 10 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.

  33. 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. Answer to question 11 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).

  34. 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. Answer to Question 12 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.

  35. 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.

  36. 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 13.2 Money Market 40 to 60% Bonds 15 to 35% Equities 15 to 35% Property 5 to 20%

  37. 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. Answer to Question 14 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.

  38. Question 15 Cameron 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

  39. 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.

  40. Answer to Question 16

  41. 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? • Answer to question 17 • Disability insurance • Income protection insurance. • Dread disease insurance.

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