A new wave of medical savings products aimed at the retirement market could follow the Katz Commission's recommendation for tax incentives to encourage individuals to set aside funds for medical costs after retirement.
In the latest Katz Commission report on benefit funds which was released last week, the commission recommends that tax on retirement be adjusted to encourage individuals to take out an annuity specifically dedicated to meeting medical scheme contributions after retirement, of which, on retirement, the first R120 000 would be tax free.
This is the first concrete recommendation to address this problem.
However, tax-free contributions towards retirement savings - whether for a pension income or medical costs - remains at a maximum of 22,5 percent of earnings.
The problem of saving for post-retirement medical costs has been debated for years because flaws in traditional medical schemes resulted in younger members with low claims subsidising older members with higher claims and led to younger members withdrawing from these schemes.
The galloping costs of medical care, which for a number of years greatly outstripped inflation, emphasised the need for alternatives.
Various ad hoc solutions were developed over the years including the so-called paragraph "c" benefit funds, which took advantage of the loopholes in the Income Tax Act.
The same Katz Commission report is recommending that paragraph "c" funds be abolished.
Barry Swartzberg, chief operations officer at Momentum Health, explains that in a previous Katz Commission report it was recommended that the present value of an individual's pension, after an initial deduction, be taxed at the date of retirement.
The size of the annuity purchased affects the amount of the initial tax deduction.
The latest report recommends that if an additional annuity is bought to meet post-retirement medical costs, it will help to reduce tax on the pension at retirement as it is recommended that an additional maximum of R120 000 for this annuity will be tax free.
Swartzberg says the future medical liability of those aged 65 was generally calculated at about R165 000, but this obviously depended on factors like life expectancy, medical inflation and investment earnings.
He considers the allowable maximum of R120 000 is reasonable, particularly if it is increased annually in line with inflation.
Swartzberg says the retirement fund structure, with some modifications, is the ideal vehicle for post-retirement medical funding.
The modifications would have to include the type of underlying assets the fund can invest in, since, to fund medical costs, high-growth investments would be needed.
Kevin McManus, tax partner at Price Waterhouse, says on the one hand the Katz Commission's recommendations are sensible, in that allowing a 22,5 percent maximum deduction for contributions should be enough if people start to save for retirement early in life.
But in reality, most people only start to save for retirement fairly late in their working careers. The commission should be providing incentives for young people to save.
Although the report addresses a number of issues that needed attention, it is unfortunate that, if adopted, its recommendations to restrict salary sacrifice schemes will add to the tax burden on middle-income earners, McManus says.