I am often challenged in trustee report back meetings about the rate of capital growth on beneficiary funds, and more specifically why the benefit in the fund has not grown as much as is expected. My response is always the same – a beneficiary fund is not a preservation vehicle and that boards should consider what outcome they are trying to achieve when making death benefit distribution decisions.
Beneficiary funds can be set up to achieve a number of different outcomes and boards of trustees should take the time to work with their service provider to understand the various options available.
The case for preservation
The Fairheads Umbrella Beneficiary Fund has an asset allocation model which invests assets according to a number of factors. One of these factors is the amount of regular income required by the guardian for general well-being of the member’s needs. The degree to which the fund grows can be adjusted by nominating a smaller or larger regular income payment.
Consider the following example:
Scenario 1 – R100 000 capital introduced for a 6 year old child, terminating at age 18 with no income payable and no capital assistance paid during the life of the beneficiary fund
The graph illustrates the projection for a 6-year-old child with a benefit of R100 000 placed in the beneficiary fund, with no income payable and no ad-hoc capital payments made. In this scenario, the benefit would grow significantly over the 12-year term, with a final termination payment of four times the initial investment – tax-free.
While this may seem an attractive proposition, the fact remains that in this scenario the child would not have benefitted from the funds during his or her formative years and the question remains, would a better outcome have been achieved if this money had been used towards providing him or her with a better education?
Contrast this with the following example:
Scenario 2 – R100 000 capital introduced for a 6-year-old child, terminating at age 18 with an income of R1 250 payable and no capital assistance paid during the life of the beneficiary fund
In this scenario, the graph illustrates the projection for the same child with the same initial benefit, however regular income payments to the guardian or caregiver are set at R1 250 per month and no capital claims are requested. If this model is applied, the entire capital base is eroded and there are no funds remaining when the child reaches the age of majority – over R180 000 has been paid out to the guardian or caregiver during the life of the beneficiary fund.
Again, this may seem an attractive proposition in certain circumstances, however, trustees should consider whether it is appropriate to pay this level of money to the guardian or caregiver with limited verification that the funds are being used for the benefit of the child. Also, is it appropriate to exhaust the entire capital based leaving no further funds for potential tertiary education?
A more balanced view is illustrated in the following example:
Scenario 3 – R100 000 capital introduced for a 6-year-old child, terminating at age 18 with an income of R700 payable and capital assistance of 5% of the capital introduced per annum paid during the life of the beneficiary fund
In this graph, it is the same child with the same benefit, however here the regular income is set at R700 per month and capital ad-hoc requests are paid at 5% of the initial capital per annum.
The key to determining what income to set for the guardian or caregiver is understanding the purpose of the benefit in the first place: Is it to provide for the well-being of the child during their formative years, or is it to provide a kick start in life once the child reaches the age of majority? A well-structured beneficiary fund with an appropriate investment strategy should be able to accommodate either of these objectives.