The first life table was written by Edmund Halley in 1693. This was pivotal for the development of modern life insurance. Interestingly enough the whole process was started by religion and gambling.
In 1654 a French nobleman and amateur mathematician by the name of Chevalier De Mèrè needed help with his gambling addiction. He wanted to know what the mathematical chances were of rolling a six in a certain sequence so he contacted his friends and fellow mathematicians Blaise Pascal and Pierre De Fermat for help. Using an old pyramid of numbers they were able to prove that a mathematical probability could be determined. This led to the development of probability theories and eventually assisted mathematicians in applying their findings to calculate life expectancy.
Earlier probability calculations was based on mortality tables provided by the Church. Clerics often drew up mortality tables in search of the role and plans of the divine creator in order to prove divine order behind the randomness of mortality.
Fast forward about 350 years and a mega industry has developed around the marketing of life insurance.
I find life insurance adverts very depressing.
The husband always dies first in what is presumably some grotesque natural disaster or from some horrible disease. The surprisingly attractive stay-at-home wife and young children are normally teary eyed until someone from the insurance company magically appears from nowhere with an undisclosed amount of money which one assumes is a lot of money because it makes the wife and children blissfully happy.
And the insurance company always has some sort of lame slogan like:
“Sexist Life – We are there when you need us most (except if you are the husband then we’re not because you are dead).”
Just for once I would like the wife to die first.
The adverts would then be much shorter as they can skip the teary eyed part and go directly to the happy scene where everyone is high-fiving and the husband has a new scantily clad supermodel girlfriend who loves watching sport and drinking beer and doesn’t whine about anything.
A man can but dream.
The general rule of thumb is that any lump sum pay-out from long-term insurance policies is a tax free benefit for the recipient under either section 10(1)(gG) or 10(1)(gI) of the Income Tax Act. The rule applies to most, if not all long-term insurance products. Examples include life insurance, funeral cover, dread disease cover, disability insurance and income protection policies.
As can be expected, due to the non-taxable nature of the pay-out, the premiums paid for these products would not be tax deductible. Before the 1st of March 2015, certain products, such as income protection policies would have seen the taxpayer enjoying a tax deduction for the premiums paid and being subject to tax when these policies would pay out. Section 23(r) was specifically introduced to prohibit the deduction and section 10(1)(gI) to exempt the income.
From an estate duty perspective, long-term insurance policies will generally form part of the deceased estate and be subject to estate duty at 20% or 25%, depending on the size of the estate. Some relief however is available to taxpayers to lessen the burden on the beneficiaries of their estate.
By nominating a specific beneficiary of a policy, whether it be a person or a trust, the value of the policy pay-out will not be subject to executors’ fees. The policy will pay out directly to the nominated beneficiary and as such the funds will not have to be administered by the executor. An executor is allowed to charge a fee of up to 3.5% of the gross value of the estate, so by nominating a beneficiary directly a substantial saving can be affected. The executor will recover the portion of estate duty applicable to the policy pay-out directly from the nominated beneficiary. If the nominated beneficiary paid some or all of the insurance premiums, the dutiable value of the policy will decrease by the aggregate amount of the premiums paid, together with 6% interest per annum.
Where the surviving spouse is nominated as the beneficiary, estate duty will be avoided completely as anything that passes to a surviving spouse in not dutiable. Furthermore, a life policy that has a child of the deceased as a beneficiary will be exempt if the policy was taken out as part of a duly registered ante-nuptial or post-nuptial agreement.
Companies will often take out insurance policies on the lives of their employees or directors. The policies usually take on one of two forms, with either the company itself being the beneficiary of the policy or the insured employee/director being the beneficiary.
Where the company bore the cost of the premiums, with the employee/director as beneficiary of the policy, the policy pay-out will be included in the gross income of the employee/director under paragraph (d)(ii) of the definition of ‘gross income’. The employee/director will be entitled to an exemption under section 10(1)(gG) if the premiums paid by the employer has been deemed to be a taxable (fringe) benefit. In layman’s terms, if the employee/director paid a monthly fringe benefit tax on the premiums incurred by the employer, then he/she shall enjoy the tax exemption.
In cases where the company itself is the beneficiary of policy (e.g. Key-man policies), the benefits of the policy will be included in the company’s gross income under paragraph (m) of the definition of ‘gross income’. Section 10(1)(gH) will exempt the policy pay-out if the premiums paid did not qualify for a deduction under section 11(w).
The premiums will qualify for deduction if the following criteria is met:
- it insures the employer against the loss of employee or director by reason of death, disablement or illness
- it is a risk policy with no cash or settlement value
- the policy is the property of the employer at time of payment of the premium
- for policies on or after 1 March 2012 the policy agreement states that 11(w) applies
- for policies before 1 March 2012 it states in an addendum that 11(w) applies
The practical implication of most key-man polices is that the company (employer) will be in the position to choose whether they want to deduct the premiums and pay tax on the future pay-out, or not deduct the premiums and enjoy an exemption of any future pay-outs. The wording of the policy and whether it specifically states that section 11(w) will apply can be dictated by the company’s desired outcome. It is important to take note that if the premium did qualify for deduction, the exemption afforded by section 10 (1)(gH) will be lost, whether the company decided to deduct the premium or not.
Estate duty implication for key-man policies is briefly as follows. Section 3(3)(a) of the Estate Duty Act will include, as deemed property, the value of any life insurance policies on the life of the deceased, irrespective who the owner of the policy was or who paid the premiums. The deceased estate can find relief and exempt policies from estate duty under the following circumstances:
- the policy was not affected by or at the instance of the deceased
- no premium was paid or borne by the deceased
- no amount due or recoverable under the policy will be paid into the estate of the deceased
- no amount has been or will be paid to, or utilized for the benefit of any relative or person wholly or partly dependent for maintenance from the deceased
Taxpayers would be well served to review all current long-term insurance policies along with their final will and testament. Substantial tax and fee savings can be achieved by ensuring that the wording of both documents are aligned.
Another example of where religion and gambling (and life insurance I suppose) overlaps is the argument in philosophy referred to as Pascal’s Wager.
The same Blaise Pascal referred to above formulated an argument in philosophy where he argues that it is better to wager that God exist than to wager that God does not exist.
Simply put, he argued that if you wager that God exist and he doesn’t, then you have nothing to lose, whereas if you wager that God does not exist and he actually does, you will burn for eternity.
This is very confusing because in the first place there are numerous other monotheistic religions with its own deity – what happens if you place your bet on the wrong god? Furthermore, an all-knowing god should be able to sniff out those hapless followers of Pascal’s philosophy with consummate ease – making it an exercise in religious futility which will disappointingly again lead to an eternity of burning.
Like tax and employer-owned life policies, it all seems so very complicated!
But then again… Maybe it’s just not.
Article by C2M Director, Carel Steenkamp, CA (SA) RA
Read other articles by Carel Steenkamp:
- I’ve had it with sex
- Death, taxes and other horrible creatures
- Tax benefits of contributing towards a Retirement Annuity
- Foreign Employment Income Exemption & Financial Emigration
- Bitcoin and Tax
Technical assistance provided by C2M Associate, Christiaan Binneman CA (SA)
For more information phone Christiaan on 021 914 0261 or email firstname.lastname@example.org.