Retirement reform is back on the table, with the government’s newest proposals likely to be considered by cabinet shortly and then released for public comment within weeks.
And the government is to increase its policeman role to give you better protection and an improved deal from the financial services industry, particularly in the wake of the problems that were exposed in the recent world economic meltdown. A significant target is the protection of retirement savings.
Banks are being singled out for special attention and, for the first time, will be brought within the ambit of market conduct legislation and subject to regulation by the Financial Services Board (FSB) as part of an overhaul of the entire financial services sector “to serve South Africa better”. The overhaul is likely to see market conduct and consumer protection of the financial services industry all under the roof of the FSB, while the Reserve Bank will take on the prudential regulation of not only the banks but also the life assurance industry. Prudential regulation ensures financial institutions can pay what they owe you when you’re due to receive it.
Currently the prudential regulation of the life industry is managed by the FSB.
The latest government proposals for retirement reform will go to Nedlac, the negotiating body on which government, the private sector, organised labour and civil society organisations are represented.
The reform process, sparked by financial services abuses, was originally scheduled to have been completed by 2010, but it was delayed by a wider overhaul of the social security system and by political differences in government.
The original proposals centred on the establishment of a national retirement savings scheme, the National Security Savings Fund, to which all employed people would have to contribute to ensure a minimum pension benefit of about 40 percent of their final pay at retirement.
The differences and expansion led to the appointment of an inter-departmental task team and high-level ministerial committee to come up with comprehensive reform proposals that would include all social security, from private sector retirement savings to the state old age grant and unemployment insurance.
Finance Minister Pravin Gordhan told Personal Finance this week that the government had made significant progress last year on retirement reform, and a paper will be released “sooner rather than later”. He says there is no intention to implement reform piecemeal.
However, he said the National Treasury is pressing ahead with a number of interim reforms on which agreement has already been reached. These follow other ad hoc reforms concerning the taxation of lump sums at retirement and of withdrawals from occupational retirement funds prior to retirement, and tighter controls on investment-linked living annuities, introduced in recent years.
In his Budget, Gordhan announced a number of new changes that will be implemented before the proposed total overhaul. These are:
- Proposals to bring pressure on the financial services industry to reduce retirement savings costs as part of a general clean-up of the financial services industry.
- A new way of claiming retirement fund tax deductions, with rand limits on how much the rich can claim (See “Revision of tax incentives to save”, above).
- The first steps towards phasing out provident funds to force all retirement fund members to use at least two-thirds of retirement savings for a pension for life (see “Beginning of the phasing out of provident funds”).
- Final proposals for the prudential investment of retirement savings.
- Opening up the provision of investment-linked living annuities, which have been the domain of the life assurance industry, to the broader industry, to increase competition and reduce costs (see “State illas on cards?”).
- Stopping the cashing in of retirement savings through divorce settlement agreements (see “Government to reconsider divorce clean-break principle”).
- Limiting tax breaks on withdrawing from an occupational retirement fund before retirement (see “More pressure on you to retain retirement money”).
Revision of tax incentives to save
A major overhaul of the tax incentives you receive for saving for retirement is under way and should be in place by March 1 next year.
The overhaul is aimed at encouraging lower- and middle-income taxpayers to save more for retirement while limiting the ability of the rich to use the system to reduce their tax obligations by placing a R200 000 cap on contributions from both you and your employer that are deductible from taxable income. The cap will be reached on annual taxable income of R888 888.
Currently you can claim deductions against taxable income up to 7.5 percent of your pensionable income used for contributions to an occupational retirement fund plus up to 15 percent of any non-pensionable income contributed to a retirement annuity (RA) fund.
Employers can currently make tax deductions for amounts up to 20 percent of your pensionable income for such things as your retirement savings, group risk life and disability assurance benefits and medical scheme contributions. The contributions are not taxed as income in your hands until you receive them as income in retirement or you cash in your savings when you change jobs.
Finance Minister Pravin Gordhan announced in the national Budget this week that, from March 1 next year, occupational pension fund and retirement annuity fund savings will be subject to the same tax system on contributions. Proposed changes include:
- An employer’s contribution on behalf of an employee will be deemed a taxable fringe benefit in the hands of the employee.
- You will be allowed deductions up to 22.5 percent of taxable income for contributions to pension, provident and RA funds. So if the amount currently paid by your employer and what you contribute make up less than 22.5 percent of your total income, you will be in exactly the same financial position as you are now. However, if you contribute the maximum 7.5 percent and your employer contributes more than 15 percent, any total amount over 22.5 percent will be disallowed as a deduction.
Ismail Momoniat, the deputy director-general of the National Treasury, says any amount paid by your employer for retirement fund administration costs and group life assurance is not included in the 22.5 percent. The calculation will be restricted to actual retirement saving contributions.
- Two thresholds are proposed – a minimum annual deduction of R12 000 and an annual maximum of R200 000.
- The distinction between pensionable and non-pensionable income falls away, with the tax-deductible amount based on a percentage of taxable earnings.
Example
The example is based on the following assumptions: annual taxable income of R450 000 (R300 000 retirement funding (pensionable) and R150 000 non-retirement funding); employer contribution of 6.5 percent to an occupational fund; employee contribution of 6.5 percent and 15 percent of non-pensionable income to an RA fund.
From a tax deduction point of view the two systems are equal on a rand-for-rand basis. However, the maximum rand amount deductible in the example under the current system is R22 500 (7.5 percent of pensionable income) plus R22 500 = R45 000 (15 percent non-pensionable).
Under the proposed structure the maximum amount deductible from taxable income would be R105 637 (22.5 percent of R469 500). So you will be able to make up the difference with additional contributions to substantially reduce your annual tax liability and to enjoy a comfortable retirement.
Government to reconsider divorce clean-break principle
The government is contemplating ways to prevent an increasing loss of retirement savings as a consequence of the clean-break principle in splitting accrued retirement benefits at divorce.
The Pension Funds Act was amended in 2007 to allow non-member spouses to lay their hands on any share of retirement benefits awarded to them in a divorce settlement on divorce.
Previously, non-member spouses had to wait for their share until the retirement of the member, and then they received only the awarded share at date of divorce without any investment growth for the period between the divorce and retirement of the member.
In terms of the legislative changes, non-member former spouses can decide whether to transfer their share to another fund (with no tax consequences) or take the share as cash, subject to lump-sum taxation.
There is growing evidence that since government implemented the clean-break principle some couples are getting divorced merely to get their hands on their retirement savings, with non-member spouses being awarded 100 percent of the retirement savings in the divorce settlement.
The money is then used for other things, leaving both the member and non-member ex-spouse to face penury in retirement.
Beginning of the phasing out of provident funds
The government intends making the first moves to phase out provident funds and they could come as early as next year.
However, the government says there will be “grandfather clauses” protecting existing rights, and implementation will be subject to thorough consultation with trade unions and other interested parties.
It says in its latest tax proposals: “To protect workers’ savings, government proposes to subject lump-sum withdrawals from provident funds to the one-third limit applying to pension and retirement annuities.”
So, as with pension funds, two-thirds of the retirement savings of provident fund members will have to be used to buy a pension for life.
Currently, provident fund members may take the entire amount of their retirement savings as a lump sum, but they cannot deduct their contributions from taxable income. However, at retirement their contributions are added to the tax-free portion of the lump sum.
The consequence is that many provident fund members spend their retirement benefits on other things – with the result that they become dependent on the state old-age grant.
More pressure on you to retain retirement money
The government is stepping up the pressure on retirement fund members to retain their retirement savings for retirement.
In a previous retirement reform document, the government signalled its intention to force retirement fund members to preserve their retirement savings until retirement. However nothing was done apart from making the taxation on the withdrawal of lump sums before retirement more onerous than at retirement.
In terms of the 2010/11 lump-sum tax tables, the first R22 500 of a lump-sum withdrawal before retirement is tax free. Any amount between R22 501 and R600 000 is taxed at 18 percent, the next R300 000 at 27 percent and any amount above R900 000 at 36 percent. This remains unchanged for the 2011/12 tax year.
However, the tax treatment of lump sums at retirement has been enhanced, making it even more attractive to keep your savings invested until retirement. It is proposed that the first R315 000 (up R15 000) of a lump sum at retirement be tax free, the next R315 000 be taxed at 18 percent, the next R315 000 be taxed at 27 percent and any amount over R945 001 be taxed at 36 percent.
State illas on the cards?
The sale of investment-linked living annuities (illas), currently the preserve of life assurers, is scheduled to get a lot more competitive, with more product providers, including the government with its successful RSA Retail Bonds, being allowed to enter the market.
The retail bonds were launched by the government to induce banks to be more competitive with their savings interest rates. Since last year, retail bond investors have been allowed monthly interest withdrawals, paving the way for them to be used as a pension instrument.