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Case Study M Botha 1. Background information. You have recently interviewed Cameron and Margaret Wriothesley and obtained the following information from.

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Presentation on theme: "Case Study M Botha 1. Background information. You have recently interviewed Cameron and Margaret Wriothesley and obtained the following information from."— Presentation transcript:

1 Case Study M Botha 1

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 R per year (current value) for the duration of his 4 (four) year course. This amount must make provision for inflationary increases. 2

3 Cameron was seriously injured three years ago when his motor boat collided with a fishing trawler in April 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. 3

4 4 (i)A total retirement benefit of R9.6 million (R ) of which he commuted one-third for a lump sum of R3.2 million (R ). The after-tax amount was used, partly to purchase 55% of the shareholding in a company in which both he and his wife are currently employed, and partly to make some investments. The investments made are included in the list of his assets which is provided below. (ii)The remaining two-thirds of R6.4 million (R ) were used to acquire a “living annuity”. Since July 2011 he has taken the minimum drawdown amount of 2.5% per year. The value of the “living annuity” assets is currently R6.45 million (R ). He has nominated his wife, Margaret, as beneficiary to receive the benefit in the event of his death.

5 5 (i)He donated R to Margaret and she invested it in a money market account in her own name. She earns interest of 6% per annum. The purpose of the donation was to provide Margaret with interest income so she could qualify for the interest exemption in terms of section 10(1) of the Income Tax Act (the current exemption is R23 800). (ii)An amount of R was invested in a voluntary purchased annuity for a fixed period of 10 (ten) years. Cameron is the annuitant. The annuity is paid in monthly amounts of R The capital (tax- free) element of each monthly amount is R He has so far received 24 (twenty-four) of the total of 120 (one-hundred and- twenty) monthly annuity amounts payable under the contract. The following investments were made from the after-tax lump sum that he received at retirement:

6 6 (iii)He invested R in RSA Retail Savings Bonds (RSA RSB’s) at 9% per annum. Interest is paid semi-annually. The term is 5 years and commenced on 1 August The interest is paid out to him (not reinvested in RSA RSB’s).

7 7 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 R 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.

8 8 The total value of all the issued shareholding (100%) in the company was recently valued at R 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:

9 9 On Cameron’s life:This policy is owned by Thomas. It is a pure risk policy and the death claim value is R Thomas pays the monthly premium of R On Thomas’s life:This policy is owned by the Cameron Wriothesley Family Trust. It is a pure risk policy. The death claim value is R The trust pays the monthly premium of R1 240.

10 10 AssetMarket Value Base Cost House in Rondebosch (primary residence)R R RSA Retail Savings BondsR Loan - Wriothesley Family TrustR Assets in a living annuity accountR Motor vehicleR R Sundry personal use assetsR R Cameron’s assets Cameron currently owns the following assets.

11 11 Policy 1A pure risk policy with a death claim value of R His wife is nominated as beneficiary. The monthly premium is R2 200 per month. Policy 2A pure risk policy with a death claim value of R His two children are nominated as beneficiaries in equal shares. The monthly premium is R1 800 per month. He also owns life insurance policies on his own life. They are:

12 12 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 R per annum to the RA. The current value of his interest in the fund is R 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 R into his existing retirement annuity fund (it is included in the contribution of R which is mentioned above). He does not know the exact tax consequences this action.

13 13 Outstanding bond on primary residenceR Car loanR The outstanding term of his housing loan is 8 (eight) years. The interest rate payable is 8.5% per annum and his monthly instalment is R His last instalment will be due on his retirement date when he turns 60. The interest rate on the car loan is 9.5% per annum and the remaining term is 2 years (24 months). His monthly instalment is R Cameron’s liabilities Cameron has the following liabilities:

14 14 Assets Liabilities Furniture and effects Credit card Motor car Money market account Collective investment scheme R R Margaret’s assets and liabilities are as follows:

15 15 (i)His employer contributes the full amount of the medical scheme membership of R3 600 per month. Cameron, Margaret and their son David are the members (three members). (ii)His employer pays the monthly premium of an income protection policy for Cameron’s benefit. The monthly premium is R The policy was taken out on 1 March Their income from employment is as follows: Cameron earns an annual salary of R (R per month). He receives the following other benefits from his employer:

16 16 Margaret is employed as an administrative assistant at the same company and earns a salary of R per month. She receives no fringe benefits.

17 17 Cameron’s monthly income and expenditure are as follows: Income Payments Cameron’s salary before tax Annuity (voluntary)7 929 Living annuity drawdown (R ÷ 12) Interest on RSA Retail Savings Bonds3 450 Instalment housing loan Car loan instalment Contribution to RA (R ÷ 12) Insurance premiums Income tax (estimated) Other (household expenses etc.) Surplus

18 18 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.

19 19 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.

20 20 1. Use the 2013/2014 tax tables in respect of any tax calculation that you do. 2.Assume an inflation rate of 6% per annum. 3. In respect of any life insurance that you recommend on Cameron’s life you must assume a premium of R14 per month per R of sum insured. 4.Use the investment growth rates as given in each particular question. Annexure Assumptions and rates to be used in answering this examination paper.

21 21 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.

22 22 Answer to question 1 Salary Fringe benefits - Medical scheme contributions Income protection policy premium Living annuity drawdown Annuity (voluntary) (R7 929  12) Interest RSA Retail Bonds Deemed interest (donation) Gross Income

23 23 Gross Income Less: Exemptions Capital element annuity Interest Less: Income protection premium RA contribution Less: Medical [ – 4(7 752) – 0.075( )] 0 Taxable income Tax on R Less: Rebate Tax payable

24 24 Maximum RA contribution is 15% of ( – ). Therefore R Monthly tax is R ÷ 12 = R23 139

25 25 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.

26 26 Answer to question 2 RA lump sum Commuted living annuity Plus: Prior RFLB Tax on R (2014 RFLB table) Less: Tax on Prior RFLB of R Tax payable The estate liable but can recover the tax from Margaret.

27 27 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 R 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.

28 28 Answer to Question 3 Commutation amount Less: Capital element (exempt) [R – (24 × 5 000)] Tax = 40% of R = R9 905 The remaining amount after tax is R (R – R9 905).

29 29 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 R and that funeral expenses are R Assume that Margaret is nominated as beneficiary of the living annuity.

30 30 House in Rondebosch (primary residence) RSA Retail Bonds Loan owed to him by Wriothesley Family Trust Motor vehicle Sundry personal use assets Answer to question 4 The following assets will attract executor’s remuneration Executor’s remuneration 3.99% of R Admin fees Funeral expenses CGT (roll-over) 0 Total costs

31 31 Capital needed 1 P/YR Begin mode PMT 34N I/YR(8 – 6 = 2) then 2 ÷ 1.06 = PVR 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 R 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

32 32 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.

33 33 Capital available RSA Retail Bonds Loan Wriothesley Family Trust Less: Liabilities – Car loan Estate expenses and funeral Plus: Living annuity (not commuted) Life insurance payable to her RA (assumed taken as living annuity) Money market (own asset) CIS (own asset) Less: Own liabilities Capital available Answer to Question 6

34 34 Shortfall=R minus R =R 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 R ÷  14 = R1 526 per month

35 35 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 R to an RA fund. His maximum deduction is R 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.

36 36 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.

37 37 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.

38 38 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.

39 39 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.

40 40 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.

41 41 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 R in executor’s remuneration ( of R ).

42 42 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 Discussion: New paragraph 12A of Eight Schedule.

43 43 Question 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.

44 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% Bonds15 to 35% Equities15 to 35% Property 5 to 20%

45 45 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 R 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.

46 46 Current cost is R per annum. Cost in first year (in three years’ time) Begin mode PV 3N 6I/YR FV 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

47 47 Then 1 P/YR Begin mode PMT 4N I/YR(8 – 6 = 2) then 2 ÷ 1.06 = PVR P/YR Begin mode FV 3 ShiftN 8I/YR PMTR9 084

48 48 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 R per month as given.

49 49 Cameron’s salary before tax Annuity (voluntary) commuted0 Living annuity drawdown Interest on RSA Retail Bonds3 450 Instalment housing loan 0 Car loan instalment Contribution to RA (R ÷ 12) Insurance premiums Income tax (actual) R Other (household expenses etc.) New policy premium Investment study fees Surplus/Shortfall xxxxx Answer to Question 16

50 50 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.

51 51 Question 18 Cameron wants to know whether he should commute the voluntary annuity in order to redeem his housing loan of R , or whether it is better not to commute the annuity for this purpose. Show your calculations and advise him as to which one of the two options is the best.

52 52 Annuity (monthly)7 929 Less: Capital element5 000 Taxable portion annuity (monthly)2 929 Answer to question 18 The after-tax lump sum that he will receive if he commutes the voluntary annuity is R That is also the outstanding value of his loan. The rate of interest on his bond is 8,5%. He must therefore earn an after-tax rate of more than 8,5% on the annuity in order not to repay the bond. The after-tax rate of the annuity

53 53 Tax on annuity (monthly)= R2 929  40% = R After-tax annuity= R7 929 – R = R END Mode 12 P/YR /-PV PMT 8 ShiftN I/YR7.04% The after-tax return that he gets on the current capital value (if commuted) of the annuity is:

54 54 It is less than the 8.5% that he pays on the bond. He should commute the annuity to redeem the bond. Note: An alternative answer is that the after-tax annuity is R which is smaller than the bond instalment of R If he continues with the annuity he will have to continue to pay the difference of R per month out of pocket. If he commutes the annuity he can redeem the bond and save R per month.

55 55 Question 19 Cameron will soon appear on the new local TV series Dragons Den where he will apply for an investment in return for a one-third share of the company. How should such a deal be structured. Give two options. Answer to question 19 Option 1: Sell one-third of each of the current shareholder’s shares. Option 2: Issue the remaining 50 authorised shares. The latter best. Discussion: Shareholding - new Companies Act.

56 56 Question 20 What is the amount that the Dragons will have to invest for a one-third share in the company? Answer to question 20 Two-thirds=R Therefore one-third =R

57 57 Question 21 Discuss an alternative method for the sale of the shares of a deceased shareholder. Answer to question 21 Discussion share buy-back.

58 Thank you End 58

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