The financial services industry is linked in a variety of ways to the attorneys’ profession. This is especially apparent when attorneys drafting divorce settlement agreements are faced with various financial products like pension funds, retirement annuity funds and endowments. It is imperative that every practising attorney understands the rules of each particular product that forms section of the financial planning process. Source: Tricia Reed BA LLB HDip (Tax) (UKZN) CFP (UFS) is a senior legal adviser to an insurance company in Durban.
The financial services industry is linked in various ways to the attorneys’ profession. This is especially apparent when attorneys drafting divorce settlement agreements are faced with various financial products like pension funds, retirement annuity funds and endowments.
It is imperative that every practising attorney understands the rules of each particular product that forms section of the financial planning process. At the outset, practitioners should be aware of the issues set out below. These are savings vehicles that are subject to several Acts, the most important being the Long-term Insurance Act 52 of 1998. Section 54 read together with the regulations, states such rules. Unlike many other financial products, endowments can be ceded, and are often ceded when it comes to divorce settlements.
However, attorneys should be aware that this may have the effect of making such policies second-hand policies and, therefore, when it comes to the eighth schedule to the Income Tax Act 58 of 1962, subject to Capital Gains Tax. Attorneys acting for a client who is the owner of such a policy, should discourage the client from making assertions in a divorce agreement regarding the maturity value of the policy.
Financial planners give clients illustrative values of what the policy may mature at. These figures are reliant on many factors. A customer could find himself in the problem where in fact the matured policy value is less than anticipated. Your client, having guaranteed an increased figure in the divorce agreement, finds himself in the unattractive position of experiencing to create up for that shortfall. They are savings that have as their primary purpose the provision of capital at retirement. Additionally it is prudent for attorneys to determine which kind of investment your client holds.
References to endowment policies in the divorce agreement tend to be incorrect and the underlying policy is quite ordinarily a retirement annuity policy, which can’t be ceded. The result is that the ongoing parties cannot perform what that they had agreed to, and the attorney may need to start renegotiating with two irate clients. Pension savings are reliant on an employer-employee relationship. Pension moneys can’t be withdrawn except on retirement or resignation.
On resignation, the entire pension benefit could be withdrawn. Tax is paid at the member spouses’ average tax rate. At retirement only one-third of the pension benefit could be used cash, the rest of the two-thirds can be used to get an annuity (a pension). Often divorce agreements drafted by attorneys enable 50% of the pension interest to be paid to the nonmember spouse. No mention is constructed of tax.
If the divorce occurs near to the known member spouse’s retirement, this agreement cannot, used, get effect to as the member spouse can commute only 1/3, which he must pay tax then.
The amount open to the nonmember spouse is much less compared to the 50% decided to at divorce. Furthermore, tax is mentioned. Annuities that are being received when the spouses opt to divorce often form the single largest asset in the estate and so are usually the only income source.
The annuity (pension) is paid to the average person spouse who was simply previously the person in the retirement annuity or pension fund. Attorneys drafting settlement agreements often enable the ‘splitting’ of the annuity and the payment of half of the annuity in to the bank-account of the nonmember spouse. Attorneys must be aware that used insurance firms which underwrite the annuity (or pension) won’t pay into any account apart from the member spouse’s.
Furthermore the known member spouse pays all the tax. Attorneys should be aware of what the merchandise provider shall allow used. Usually the annuity may be the largest asset in the estate even though it might be more convenient for the members to pay the member and non-member separately, this cannot be done. The effect of this is that the member spouse will receive the annuity and pay it over similar to a ‘maintenance’ payment to the non-member spouse.
Attorneys should also be aware that insurers will not pay funds into any bank account other than an account held in a local bank. As mentioned above, attorneys would do well to educate their clients on the effects of income tax involving pension withdrawals and payments from retirement annuities and pension funds at retirement.
- J.G. Wentworth
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- Selling future lump sum payments
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- For six years of experience in the preparation of annuities
Many settlement agreements are silent on the tax treatment of pension payments. The non-member spouses may not fully understand that pensions are subject to income tax and may therefore get a rude awakening when the R1 million they expect to receive is R700 000 after tax. The shortfall is substantial and the attorney would do well to clear up expectations so that there is no disappointment on the part of the client. In addition attorneys must be aware that only one-third of a retirement annuity or a pension fund can be commuted, that is, taken in cash.
Again such a commutation will be subject to tax at the member spouse’s average rate. Problems such as the above were well illustrated in the case of Old Mutual Life Assurance Company (SA) Ltd and Another v Swemmer 2004 (5) 373 (SCA).
The facts briefly were that the respondent was divorced from her husband. As part of the settlement agreement, Mrs Swemmer, the non-member spouse, was awarded ‘as her exclusive property’ two retirement annuities, one with Old Mutual and one with Sanlam. The husband was the member of the retirement annuity funds and after the divorce, continued to pay the premiums. When the member spouse turned 55 (the earliest date on which you can retire from a retirement annuity (a person may never withdraw)), the respondent requested the insurers to pay the full proceeds of the fund to her.
The contract term of the annuities ran until the member turned 60, but the non-member spouse as the ‘owner’ of the policies, wanted the funds on the member spouse’s 55th birthday.
The insurers had objected on two grounds – the first related to s 7 of the Divorce Act 70 of 1979, and the second to the relationship between the member and insurer. This case serves to illustrate what is a widely misunderstood concept of financial products.
If as an attorney in a divorce matter, a pension or retirement annuity forms section of the assets of the parties, care must be taken to ensure that a ‘cession’ is not effected.
In addition it must be explained to clients that pension interest is paid only on the date of withdrawal (pension funds only) or retirement by the member spouse from the fund. Quite simply that date on which the pension accrues to the member. This may in practice be 20 years after the divorce.
This effectively means that the non-member spouse will receive the pension interest with no interest or growth only on that date. Government has acknowledged that there are inequitable consequences regarding pension moneys on divorce.