Life assurance companies may be putting the tax benefits that you receive from saving for retirement at risk because their funds are not acting in terms of the rules for tax-incentivised retirement savings funds.
This week Vuyani Ngalwana, the Pension Funds Adjudicator released another ruling that questions whether retirement savings vehicles, including retirement annuity (RA) and preservation funds, administered by the life assurance industry meet the requirements of the Income Tax Act.
The South African Revenue Service (SARS) may stop recognising the funds that do not meet its requirements, which means you could lose your tax advantages.
Ngalwana ruled that the Metropolitan Preservation Provident Fund illegally applied new rules retrospectively when it prevented a member from making a second withdrawal from the preservation fund.
In arguing its case with the adjudicator, the fund says that the member, Mr M, was not permitted to make a second withdrawal because of a practice note issued by SARS in 1998 in terms of the Income Tax Act .
This note states that a preservation fund member is not allowed to make more than one withdrawal from a preservation fund before retirement.
Ngalwana, however, says that when Mr M made the application for the second withdrawal, there was no fund rule in place to limit him to one withdrawal, even though this was contrary to the SARS ruling.
Naleen Jeram, the deputy Pension Funds Adjudicator, says the Metropolitan fund made the rule change limiting the number of withdrawals in 1991, three years after SARS issued its practice note.
He says the courts have found the retirement funds cannot act on rule changes retrospectively.
The consequence of this is that Metropolitan could lose its tax status because it failed to act immediately on the SARS practice note in 1998.
Members of preservation funds receive three tax advantages. These are:
- You can transfer the proceeds of your retirement savings when you move your benefits from a employer-sponsored fund to a preservation-fund tax free. In other words, you preserve the tax advantage that you received while contributing to the employer-sponsored fund.
This tax advantage is that you were able to deduct your contributions to the original fund from your taxable income - you do not pay tax on income contributed to a tax-incentivised retirement fund. If you cash in your retirement savings before retirement, you will have to pay tax on the proceeds.
- While your money is in the preservation fund, the interest income, net rental income from property investments and foreign dividends are taxed at 18 percent rather than at the higher rates that are applied to other investments.
- On retirement you benefit from the same preferential tax rates on any lump-sum withdrawn from a preservation fund, including a tax-free portion equal to that you would have received if you had remained with the original fund.
Jeram says that your preservation fund must be registered with SARS if it is to qualify for these tax benefits. And for a fund to be registered with SARS, it must abide by the Income Tax Act and the directives issued by SARS in terms of the Act.
Failing to abide by these terms means that SARS is obliged to deregister the fund. The result is that you lose the tax benefits.
In rulings handed down earlier this year, Ngalwana indicated that a number of retirement annuity funds may be contravening the Income Tax Act because they were levying confiscatory penalties on members, who were forced to reduce or halt contribution payments because of their personal financial situations.
Ngalwana found that the penalties were not contained in the rules of the retirement funds and therefore could not be levied.
In these cases, the penalties could contravene other conditions under which SARS registers tax-incentivised retirement vehicles. These other conditions include an obligation for a fund to be governed in terms of its rules.
At the time of the earlier rulings, Vlok Symington, the manager of personal income tax at SARS, said that if SARS found that a fund had not complied with its rules, then SARS would have to withdraw the approved status of the fund.
This means that the fund will no longer be recognised for tax purposes and that it will have to forfeit its tax-privileged status.
In the latest case, the complainant, Mr M, was employed by Metropolitan Life and was a member of the staff fund. He withdrew from the fund in April 2000.
At the time of his withdrawal, the rules of the fund required the withdrawal benefit to be transferred to a preservation fund. The total amount of his benefit was R126 228. Some R5 600 of that amount was deducted from his benefit at his request and the balance transferred to the preservation fund.
In an undated letter to the preservation fund, he requested a further cash withdrawal of R14 000 from his benefit. In a letter dated July 16, 2001, the preservation fund advised that it was unable to accede to his request.
Two arguments were advanced to Ngalwana by the fund to justify its decision not to accede to the complainant's request.
The first was the argument about the SARS instruction.
The second argument is that in terms of the rules of the preservation fund, the previous employer (Metropolitan) has a right to impose a restriction on any cash withdrawal from a preservation fund to which the retirement savings of a member have been transferred.
Ngalwana asked the fund to provide him with details of the prohibition the employer had imposed on cash withdrawals. The fund was unable to give him any details.
Ngalwana says that not only could the fund not provide any details of the prohibition but "there is not even evidence that the employer applied its mind to the complainant's request".
Ngalwana ordered the Metropolitan Preservation Provident Fund to pay Mr M R14 000 from the monies held by that fund on his behalf.
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The Metropolitan Preservation Provident Fund has accepted the Pension Fund Adjudicator's ruling and will pay the cash withdrawal benefit as ordered to the fund member, Mr M.