By Vickie Lange, Institutional Best Practice Specialist at Alexander Forbes
Last year the tax changes to all retirement funds and the retirement benefit changes to provident funds (together known as T-day changes) which were originally scheduled for 1 March 2015 were delayed to 1 March 2016. This was partly due to rumours and misunderstanding of Government’s retirement reform proposals, which resulted in some workers wanting to resign in order to access pension savings.
National Treasury confirmed in their press release issued on 3 December that the long-awaited retirement reform will go ahead on 1 March 2016. The 2015 Taxation Laws Amendment Bill has been passed by both Houses of Parliament and now awaits assent of the President.
National Treasury has moved to dispel rumours and correct the public’s understanding of the intention of these retirement fund changes. They have reaffirmed that the Government has no intention of nationalising retirement savings and that these changes do not stop members from accessing their savings when leaving an employer. Government has advised workers not to risk losing their jobs by resigning from their employers to access their retirement savings.
Alexander Forbes therefore believes that there is no good reason for members to resign from their employers to access their savings. The changes are beneficial for most working South Africans as it encourages greater savings for retirement and addresses issues in the retirement system. Furthermore, existing rights are protected.
It has been a long journey to get to this point, and our view is that the implementation of T-day changes is a positive development. This sentiment seems to be shared by many stakeholders in the industry.
Why retirement reform is important
Our research shows that most people retire with less than one-third of their final salary to live on in retirement, which does not sustain their standard of living. The reality is that although the South African retirement system has many good features, there are a number of issues to address:
- Ensuring that everybody is protected in some way against poverty
- Ensuring that every working citizen contributes enough towards their retirement to keep their standard of living in retirement.
- Ensuring value for money of the retirement system.
The aims of retirement reform are to create a uniform retirement fund system for all types of retirement savings vehicles, such as pension, provident and retirement annuity funds. This would allow all members to be treated the same with regard to the tax treatment of the money contributed and also how benefits can be paid at retirement. Because pension, provident and retirement annuity funds are currently treated differently, a uniform system would make these simpler to understand.
Alignment of tax deductibility of contributions to all retirement funds
Currently the tax treatment of contributions to all retirement funds is not the same. Provident fund members currently receive no tax deductions for their contributions, but pension fund members receive a tax deduction of up to 7.5% of retirement funding income (similar to pensionable salary). Members contributing to retirement annuity funds receive a tax deduction of 15% of non-retirement funding income. Employer contributions to pension and provident funds are not included into taxable income as a fringe benefit, and therefore do not affect the member’s tax position, but they are deductible for the employer up to 20% of retirement funding income.
The changes from 1 March 2016 for all members regardless of the type of retirement fund you and/or your employer contribute to on your behalf:
- Future contributions to pension funds, provident funds and retirement annuity funds will be treated in the same way for tax purposes.
- Employer contributions will be included in the taxable income of employees as a fringe benefit, but will be offset by the employee’s tax deduction allowance – see the next point.
- Employees’ tax deductibility of contributions will be limited to 27.5% of the greater of remuneration or taxable income, up to a yearly limit of R350 000. This is an overall tax deductible limit that will apply collectively to all retirement funds the person contributes to (pension, provident and retirement annuity funds). Both the employee and employer contributions form part of this tax deductible limit. You can roll over any contributions above 27.5% or R350 000 into future tax years. You can claim these on assessment subject to annual tax deductible limits.
This is a benefit for most members, especially provident fund members and self-employed persons who only make use of RAs, as they can deduct more for tax purposes from 1 March 2016. Members should consider paying additional contributions to take advantage of this improvement to boost retirement savings on a tax-efficient basis.
An example of this: a provident fund member contributes 5% and his employer contributes 10% on his behalf. Under the current tax legislation, the member will not get the 5% as a tax deduction and the 10% is not included in his taxable income. Essentially the member does not get a tax break on the 5%. With the new tax changes, the member will get the full 15% as a tax deduction, subject to the R350 000 limit. This means that the member’s taxable income will be less and his take-home salary will be more, assuming the member does not exceed the R350 000 in contributions.
Currently contributions are based on pensionable salary which is typically less than remuneration (generally pensionable salaries are between 70-75% of total remuneration). Therefore, even greater tax savings can be achieved because the 27.5% will be based on the greater of taxable income or remuneration.
Unfortunately, the R350 000 limit does impact high earners. Members who have a pensionable salary of more than R1.2 million and contribute 27.5% will be limited by the R350 000 for tax deductibility purposes. Therefore any contribution over the R350 000 will no longer be in a tax-efficient manner, but this doesn’t mean that they shouldn’t continue to contribute in excess of this amount, as there are many other benefits to saving in a retirement fund. For example these savings will be protected from creditors, and are free from dividends tax and capital gains tax. They are also usually significantly cheaper to administer and invest than typical discretionary investments. Each individual’s circumstances may differ and these individuals could benefit by planning their affairs using an accredited financial advisor.
Buying a pension at retirement
Currently provident fund members may take their retirement benefit as a full cash lump sum and do not have to purchase an annuity (pension) from a registered insurer when they retire. However, pension fund members have to use at least two-thirds of their retirement benefit to purchase an annuity, unless the benefit is less than R75 000 (this will increase to R247 500 from 1 March 2016).
From 1 March 2016, retirement benefits from provident funds will be the same as pension funds, in respect of the part of the benefit based on contributions from 1 March 2016. The changes for provident fund members are:
- Provident funds will be subject to the same annuitisation rules as pension funds and will therefore be limited to one-third cash lump sum and annuitisation of at least two-thirds at retirement – but only in respect of future contributions.
- If the benefit which needs to be partially annuitised is under R247 500 this will not apply. This means that members will have to buy an annuity (pension) from a registered insurer with at least two-thirds of their retirement benefit, unless it’s R247 500 or less.
- However vested rights (protection of retirement savings before the new legislation becomes effective) will be taken into account in the following way:
- Any provident fund balance saved prior to the implementation (1 March 2016) plus the future growth on this until retirement won’t be affected and can be accessed in cash upon retirement.
- A provident fund member who is 55 years or older on 1 March 2016 will not be affected by this change at all (in other words, the retirement benefit will be treated in the same way as it is currently being treated when they retire) if they stay a member of the same provident fund until retirement. If they transfer to another fund, they would still have vested rights, but contributions to the new fund and growth thereon will be subject to the annuitisation requirements.
Tax-free transfers between approved funds
Transfers from a pension fund, pension preservation fund, provident fund or provident preservation fund to a pension fund, pension preservation fund, provident fund, provident preservation fund or retirement annuity fund will be tax free from 1 March 2016.
The benefit of this change is that funds can now transfer members’ savings in a tax-efficient way, which should help in consolidating the industry and reducing costs in the longer term.
Estate duty will apply to post-tax contributions to funds
Currently, all contributions to retirement funds are excluded from the dutiable estate of a deceased member, regardless of whether the contributions were tax deductible or not. Members typically increased contributions to their funds, sometimes with the only purpose of avoiding estate duty on these retirement savings.
SARS will be putting an end to this practice by making post-tax contributions estate dutiable. Any amount contributed to a pension fund, provident fund or retirement annuity fund after 1 March 2015, which did not rank as a tax deduction (in other words the contributions which were in excess of the tax deductible limits), will be included in the dutiable estate of a person who died after 1 January 2016.
Essentially a tax loophole is being closed by implementing this change. It is important for members to be aware of this when doing their estate planning.
Some of the implications we could expect to see as a result of these changes include:
- Further consolidation of funds in the industry. Where employers have multiple retirement funds, they may look to harmonise benefits and consolidate their funds. This should result in more cost-efficient management and administration of funds.
- Trustees and employers are likely to conduct a review of the benefits offered to members. The benefit design of funds may be improved by incorporating more tax-efficient contribution rates and may be made simpler and more transparent. Some employers might even do away with the concept of pensionable salary, which is currently aligned to retirement funding income recognised by SARS. From 1 March 2016, SARS will no longer base the tax deductibility of contributions on retirement funding income in respect of pension and provident funds, and on non-retirement funding income in respect of retirement annuity funds. Instead the tax deductibility will be based on the greater of remuneration or taxable income.Group insurance benefits, such as group life assurance and disability income benefits are typically based on pensionable salaries. Therefore we may see changes to these benefits too, but most likely only to the extent of rebasing these benefits to remuneration as opposed to pensionable salaries.
- Over time there may be improvements in the savings rates and better take-up of annuitisation which helps deal with longevity risk (risk of pensioners outliving their savings).
- Trustees will be making changes to fund rules to align with the new legislation and to implement any changes to the benefit design of funds.
- Extensive communication by funds (and perhaps employers) to inform members of the changes and how they will specifically be impacted.