Tax efficient transfer of family wealth: How R300 000 a year can save a South African family millions

A married couple who donate R300 000 a year to their children for 20 years move approximately R6 million out of their estate (without interim growth accounted for), but at 10% annual compound growth that money is worth about R18.9 million by year 20.

Had it stayed in their estate, the South African Revenue Service (Sars) would have collected roughly R6.5 million in estate duty and capital gains tax (CGT) on death. This makes the case for transferring surplus capital (legally) out of your dutiable estate, to your eventual beneficiaries, to invest in a further tax-efficient vehicle.

Few families use the simplest tool the law offers, which is the annual donations tax exemption. Almost all estate structuring conversations start with: life cover, trusts, wills, etc., but this strategy costs nothing to set up, needs no trust deed, and works best for exactly the families who think they don’t need it. Those whose retirement is already well funded and whose dutiable estate keeps growing even further.

Read: Effective strategies for intergenerational wealth management

This article walks through how the strategy works, puts numbers on a practical 20-year example, and ends with a practical guide for parents who want to execute it for themselves and their children.

How does it work, and what are the rules?

When a South African taxpayer passes away, there are three various taxes and costs applicable to its dutiable estate/assets:

1. Estate duty
2. Capital gains tax (death is a CGT event as it is seen as a deemed disposal of assets)
3. Executor’s fees

These taxes and costs may lead to a situation where the beneficiaries of parents may inherit substantially less than they planned for. As a ballpark figure, these collected taxes and costs could reduce the estate by about 25-35%, all things considered.

How can this be addressed by one of the simplest tools available, but is almost never used?

Every South African resident individual may donate up to R150 000 per tax year free of donations tax. A married couple can therefore give R300 000 a year between them: R150 000 to each of two children. Above the exemption, donations tax is 20% (25% on cumulative donations above R30 million), so staying within the limit is important to not pay any tax.

There are four other rules that turn this exemption into a powerful planning tool:

The last point is the one most families underestimate. The exemption caps what you give each year, but it does not cap to what value those donations can grow to in the hands of the receiver(s)/children.

Read: The taxman’s gift – and the hidden catch that could cost your family millions

The practical 20-year example

Meet a hypothetical couple in their mid 40s. Both are still earning, their retirement savings are on track, and they hold a sizeable discretionary portfolio. They have two young children and decide to donate the full exemption every year, for 20 years.

In one example the parents keep the R300 000 a year in their own estate/portfolio. In the other they donate it. Everything else remains constant.

Saving 1: a smaller estate, with less tax

Illustrative projection · R300 000 donated at the start of each year, at 10% growth

By year 20 the parents have given away R6 million, yet R18.9 million sits outside their estate when accounting for the compound growth and the value it would have been inside their own estate.

More than two-thirds of that is growth that is not on their balance sheet any longer, so it can never be taxed in their hands as it would have been.

Here is what happens to the money at year 20 if the second parent dies:

That is a difference of R6.47 million more for the children, or about R2 million in today’s money.

Illustrative projection: estate duty 25% of value after CGT and CGT 18% of growth

The savings do not stop when the donations stop. Every year the parents live after the last donation, the money keeps compounding outside their estate, in the hands of their children. If the second death is in year 30, the tax avoided increases to about R18.1 million (R3.1 million in today’s money).

Another saving is not counted for in this example: executor’s fees of up to 3.5% plus Vat are charged on gross assets in a dutiable estate.

On R18.9 million that is a further R760 000 approximately, which is basically legal fees to dissolve the estate.

Read: The family you have, the financial plan you need

Another non-financial aspect (but no less important) to keep in mind, is that the inheritance of discretionary assets can be subject to substantial delays, meaning the eventual beneficiaries can wait several months or even years for the funds to get to them, whereas in the strategy explained in my article, the funds are already in the hands of the children.

Any surplus funds inherited by the children can then go through the estate administration process without causing any issues for the children, as they already have funds to at least live off, if necessary.

Saving 2: what the children build

Illustrative projection · R46 000 a year into the tax-free savings account (TFSA) until the R500 000 lifetime limit, the surplus into a discretionary portfolio where normal taxes apply also at 10% growth

Each child’s R3 million of donations grows to R9.45 million by year 20. The TFSA is maxed out after 11 years, having taken the child’s entire R500 000 lifetime allowance, and by year 30 that R500 000 is worth R5.7 million. Every rand of that growth is free of income tax, dividends tax and CGT, for the rest of the children’s lives.

Read: Top 10 financial priorities for single mothers

The discretionary portfolio is not tax-free, but it is taxed in the child’s hands, not the parents. The child’s tax rate is usually far lower, and the child has a longer investment horizon, giving them the compound growth benefit:

• Each child has their own R40 000 annual CGT exclusion. Realising R40 000 of gains a year and reinvesting resets the base cost at no tax cost.
• A student with little other income pays very little. For example, a R300 000 gain realised at age 20 leaves R104 000 of taxable gain after the exclusion and 40% inclusion, and the tax on that is about R1 500 after the primary rebate (2025/26 tables).
• Nothing is payable until the child actually sells, so the liability can be deferred for decades.

Compare that with the parents, who would pay 45% income tax on interest and foreign dividends and 18% CGT on the same portfolio for as long as they owned it.

This, however, is secondary to the actual benefit in terms of estate duty in the case where the parents pass away with more funds in their estate than they require for a comfortable retirement.

What it could be worth at various points in future:

If the strategy starts in the year a child is born, each child turns 18 with about R7.5 million, or R2.6 million in today’s money. The donations continue until age 20 and the money keeps compounding after that.

The TFSA alone grows to R9.2 million by 35 from just R500 000 of contributions made before the child turned 11. That is what a long time horizon does: the child’s age is the most valuable asset in this plan, as I have pointed out previously.

Families who start later still benefit, just less. A child who is 10 when the plan begins has eight years of growth by 18 instead of 18, so the earlier the first donation, the bigger the result.

The benefits, however, still remain for any family where the parents have enough assets for a comfortable retirement, where children will be the eventual beneficiaries.

Read: Why having a will is the first step – but not enough

Traps to look out for

The strategy is simple, but a few rules can undo part of the benefit if ignored.

• Income attribution while children are minors. Under section 7(3) of the Income Tax Act, income earned on money a parent donates to a minor child is taxed in the parent’s hands. Paragraph 69 of the Eighth Schedule does the same for capital gains. This does not affect the TFSA, where the income is exempt anyway, nor the estate duty saving. It does mean that, until 18, the discretionary portfolio should favour growth over interest and foreign income.
• The exemption is only per tax year. The R150 000 resets on 1 March each year and unused amounts do not carry forward. Missing a year is a permanent loss of that year’s saving/donation.
• Do not exceed the limits. Donations above R150 000 per donor attract 20% donations tax. TFSA contributions above R46 000 a year or R500 000 in a lifetime attract a 40% penalty on the excess.
• At 18 the money belongs to the child. Majority in South Africa is 18. From then the child has full legal control of their TFSA and portfolio, and the parents can’t stop them withdrawing it. It is therefore important to coach and learn your children about investments and compound growth.
• Keep enough for yourselves. The plan works only if the parents’ own retirement is secure without the donated money. Fund donations from discretionary investments, never from retirement funds.
• Your estate still needs cash. A smaller estate means less duty, but executors still need liquidity for the duty, CGT and costs that will be applicable.

Read: Are you making these three costly TFSA mistakes?

A practical guide for parents

1. Check affordability first. Ask your wealth manager to model your retirement with and without the donations, including a stress-test scenario. If your projected withdrawal rate stays comfortably below about 4%, the donations are affordable.
2. Open the accounts in the child’s name. Open a TFSA and a discretionary unit trust or share portfolio for each child, with you as guardian and signatory while they are minors. Pay the money directly from each parent’s account.
3. Fill the TFSA first. Put R46 000 into the TFSA every year until the R500 000 lifetime limit is reached, then direct the full donation to the discretionary portfolio.
4. Invest for growth. With a 20-year-plus horizon, a diversified equity-exposed portfolio is usually appropriate.
5. Keep a paper trail. Record each donation.
6. Use the child’s own CGT exclusion. Once a child turns 18, realise up to R40 000 of gains in the discretionary portfolio each year and reinvest, so their base cost keeps pace with growth.
7. Prepare the child for 18. Start money conversations early. By the time control passes, the child should understand what the money is for, how it is invested and why it should be left to grow. Show the results of the compound growth of the child’s own portfolio.
8. Update your wills. State whether lifetime donations must be taken into account when your estate is divided, so that children who receive different amounts are treated as you intend.
9. Review every year. Check the current exemption and TFSA limits after each February Budget, and review returns, spending and the plan’s fit with the rest of your estate plan.

Read: Succession strategies for preserving generational wealth

For a family whose retirement is already secure, R300 000 a year is a modest donation. Over 20 years it can move R18.9 million out of the parents’ estate, save R6.5 million in death taxes (more the longer the parents live), and give each child a seven- or eight-figure head start with a tax-free core that grows for life.

It also assists in helping the children whilst the parents are still alive, and the children are in a phase of life where they can actually use the funds, instead of a scenario where the children inherit the funds when they are 50-60 themselves, and do not necessarily need the funds and where these funds are then taxed more aggressively in both the parents estates and in the children’s hands.

It is not a complete estate plan. Families with a business, farm or property portfolio, or who want more control over when children gain access, should discuss how a trust, a will and life cover fit alongside annual donations.

Donating to a trust also uses the exemption, but trusts bring their own tax costs and rules. Annual donations are simply the easiest first step, and the one that rewards an early start most. This is the easiest, most valuable strategy to follow first.

These are illustrative projections based on the assumptions stated, not guarantees. Returns, inflation and tax law will differ. The figures used for the donations tax exemption (R150 000) and TFSA limit (R46 000) should be confirmed against current Sars rules. This article is general information and does not constitute personal financial, tax or legal advice. Speak to a qualified wealth manager.