Why beneficiary nominations are central to estate planning

Willie Fourie, Head of Estate and Trust Services, PSG Wealth

The annual review of your financial and estate plan is an opportunity to assess and reconsider the underlying assets in your estate. However, reviewing beneficiary nominations on policies is often neglected during this process.

A well-executed financial plan involves a proper analysis of assets, liabilities, life policies and retirement benefits, which ultimately translates into a properly structured and implemented estate plan. A proper process and structured annual review help ensure that your circumstances are considered in totality.  The correct use of beneficiary nominations on policies ensures a truly robust financial- and estate plan. It’s also important to dispel any misconceptions so you can prepare properly.

Better understanding beneficiary nominations

A beneficiary nomination is essentially an agreement between the policyholder and the insurance company (policy provider). In this agreement (such as an endowment, life insurance policy or living annuity), the insurer undertakes to pay the proceeds of the policy to the nominated persons on the death of the policyholder. This is commonly referred to as the stipulatio alteri or a benefit for a third party and should be fully understood before nominations are made. 

Without going into specific detail, a beneficiary nomination can be changed by the life insured during their lifetime. This must be done in writing to the insurer, and it is important to note that a will document is not sufficient to change a beneficiary nomination.

The top considerations include the type of policy and the purpose for which it was taken out (an example might be a claim for maintenance from a divorced spouse, or to fund tertiary education); the effect of this structure on the administration of the deceased estate; and whether it fits into the existing plan, taking a holistic view of the estate owner’s estate and financial plan as a whole. 

Is a change needed?

Amendments to financial assets, legislation updates, or changes to personal circumstances often result in a need to review beneficiary nominations. This is particularly the case when dealing with life policies. An example would be when a child completes their tertiary studies and the proceeds of a life policy are no longer required to fund the education. Unfortunately, policies are often cancelled without taking all circumstances into account, but it’s best to review the original purpose of a policy as no estate plan can be maintained if one of the pillars of its success is removed without due consideration.

Exceptions apply to retirement funds

You can nominate whomever you wish as the beneficiary on a life policy, but this is not necessarily the case for retirement products that fall under the ambit of section 37c of the Pension Funds Act. In these cases, trustees of the fund must first ensure that any dependents are catered for before nominees will be considered. There are specific legal provisions and formulae that funds apply in deciding on how assets are allocated. Nonetheless, it is essential to ensure that your list of nominated dependents and beneficiaries remains up to date as part of your annual estate planning review. Living annuities do not fall under the Pension Funds Act, but rather the Long-term Insurance Act, and therefore, the provisions of section 37c do not apply.

Estate duty still applies

A common misconception is that in nominating a beneficiary for the proceeds of a policy, the assets are removed from the deceased’s estate, and are therefore not subject to estate duty. This is not so. The effect of the nomination is merely that the proceeds are paid directly to the beneficiary and therefore result in a saving in executor’s fees payable on the proceeds.

The deceased estate will not be liable for the full amount of estate duty if the proceeds of a policy are paid to a nominated beneficiary, and the executor will have to apply an apportionment for estate duty between the estate and the nominated beneficiary.

Estate liquidity may be impacted

The liquidity of the estate may be adversely affected by this nomination, as it may cause the estate to be rich in assets but poor in liquid funds. This may cause the executor of the deceased estate to sell immovable property or other assets to pay for the administration expenses of the estate, including Master’s fees, outstanding income tax and claims of creditors.

Sometimes it is important to nominate the estate for the policy proceeds, but such plans should focus on the goals of the estate planning exercise, rather than on trying to avoid taxes and fees. Many structured estate plans have failed because, although very tax- and cost-efficient, they have neglected the needs of family members. Working with a fiduciary adviser goes a long way to ensuring you’ve considered the bigger picture.