After more than five years of apparent indecision on how the massive retirement savings industry will be taxed in future, the government has launched a two-year, comprehensive review of the taxation of retirement funds, including benefits paid to members.
The final plan may differ significantly from the controversial Katz Commission proposals on retirement taxation, which, when its report was published five years ago, resulted in hasty and often incorrect decisions being made by people about to go on pension.
The review of retirement fund taxation was announced by Maria Ramos, the director-general of the National Treasury, at the Personal Finance/Old Mutual Retire Right seminar held around the country over the past two weeks.
Ramos warned that retirement fund members should not make any hasty decisions as many did in the wake of the Katz Commission report. The report "caused an enormous amount of panic" with many people taking early retirement - to their detriment.
"Please do not go and make any changes because of the review. We will not do things to the detriment of ordinary South Africans."
She appealed to the financial services industry to give individuals the best possible advice and to ensure investors received value for money for their retirement investments. This included keeping individuals properly informed and holding down costs.
Ramos said the review and implementation of a new tax regime for retirement funds would not be delayed by the three-year moratorium on capital gains tax (CGT) for retirement funds. The aim was to have the review completed within three years.
Accompanying the taxation review is the redrafting of the Pensions Fund Act by the Financial Services Board as well as a review of the social old-age pension scheme funded by the government.
Ramos said the review of retirement funding taxation had been pushed aside by other tax reforms, including: The introduction of CGT, which is now scheduled for implementation in October; the change from source-based to residence-based taxation on the worldwide income of South African residents; and the tax on foreign dividends.
Various reports and recommendations from a number of forums and investigations, including Katz, would be used by the government to draft proposals, similar to the process which led to the implementation of CGT.
There would be extensive consultation once the government had completed an initial position paper.
Ramos said she was not sure the taxation models proposed so far, including the Katz recommendations, would be followed.
Significant changes had taken place since the Katz report, including the phasing out of exchange controls and changes in the tax regime. International best practice also had to be examined.
In 1996 the government accepted five principles for a retirement fund taxation review. These were:
* Consistent treatment of the private and public sectors. This has already been introduced;
* Tax neutrality between the various forms of retirement provision (for example, provident and pension funds);
* Minimisation of arbitrage opportunities. Katz identified that the tax advantages given to retirement funding were being abused;
* A tax incentive for individuals to take out a life-long annuity (pension) at retirement, while discouraging lump-sum payments; and
* Taxation of retirement funding income when it arises rather than at retirement. This was partially implemented by a 25 percent tax on the gross interest and net rental income of retirement funds.
Ramos said it was the government's intention to produce a complete review within two years and not to make further piecemeal changes, such as the "interim" measure of taxing the income flow of retirement funds.
However, it was now necessary for the principles announced by the government in 1996 to be tested.
"This does not necessarily mean that we will abandon these prin-ciples as we proceed with the comprehensive review. We need to test whether they are still relevant."
The vested rights of retirement fund members would be taken into account when changes were made. In 1996 the government said that any new tax on lump sums would not be used to penalise people who would have paid less on lump-sum commutations under the previous tax system.
Ramos said the government still believed that one sector of savings, such as retirement funding, should not be favoured over another. She said the government's aim was to improve the level of savings, which were needed for the development of the country.
Favouring one sector of savings over another would not necessarily improve savings, while decisions to use one product rather than another because of tax incentives might not provide investors with the best results.
Another way to encourage savings was the reduction in personal income tax and the government's move to eliminate its own dissaving within two to three years.
THE KATZ COMMISSION
Here is a brief summary of the Katz Commission recommendations:
Katz on Pre-retirement
* Contributions to both pension and provident funds be tax deductible up to 22.5 percent of your pensionable income. Your contribution will be tax deductible up to 7.5 percent of your pensionable income. Your employer would be entitled to claim a further tax deduction of up to 15 percent of your pensionable income;
* For a voluntary scheme the maximum contribution be 22.5 percent of taxable income saved in any retirement vehicle; and
* The gross interest, net rental and any trading income earned by the capital in a retirement fund be taxed at a flat rate of up to 30 percent. Government has implemented this at a rate of 25 percent.
Katz on Retirement
* All your retirement benefits should be lumped together and the full amount taxed, with the first R50 000 tax free;
* Tax incentives to encourage purchase of monthly pension. Any portion taken as an annuity (regular pension payment) exempt from tax up to R120 000 of your retirement capital.
If more than R120 000 is used to purchase a monthly pension, then 50 percent of any further portion is exempt up to a maximum of R210 000 of your retirement capital.
A maximum of R380 000 of retirement capital exempt from tax on a lump sum of R540 000 or more invested in a monthly pension. The remainder taxed on a sliding scale at marginal rates up to a maximum of 45 percent would click in at R750 000 after the deduction of the R380 000 tax-free amount.
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