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Retirement reform – how does it affect you?

Treasury gives more detail in consultation paper – examples included.

GEORGE: The retirement industry has until 31 May to comment on the retirement reforms that is planned for South Africa’s economy. Above and beyond the comments by finance minister Pravin Gordhan in his 2013 Budget Speech, a further consultation document was also published on Budget day, highlighting the policy proposals for further consultation.

Draft legislation to give effect to the proposals will already be introduced over the course of 2013 with the implementation date set for 2015 or later. In the consultation paper, National Treasury makes it clear the retirement refund is, where appropriate “to nudge, rather than force, individuals into making decisions which serve their long-run interests” as it is clear to Treasury that employers which take greater responsibility for the overall financial well-being of their workers “reap the rewards of a more stable and happier work force”.

The executive summary of the consultation paper highlights the following:

Taxation of retirement funds

From an effective date, on or after 2015, called “T-day”, employer contributions to retirement funds will become a fringe benefit in the hands of employees for tax purposes. Individuals will be able to receive a tax deduction on employer and employee contributions to a pension fund, provident fund or retirement annuity fund up to 27.5% of the greater of remuneration and taxable income. A ceiling of R350 000 will apply. Special arrangements will be made for defined benefit and hybrid funds.

Governance

The duties of trustees to act independently, and free from conflicts of interest, will be strengthened. The FSB is to monitor trustee appointments, including ensuring that trustees meet ‘fit and proper’ requirements. The Financial Services Laws General Amendment Bill, 2012, which contains various provisions pertaining to governance, is currently in Parliament and the minister is to convene a trustee conference.

Preservation

In the paper Treasury says that most responses to consultation after the discussion papers were published agreed that the current system of paying cash withdrawal benefits virtually automatically when individuals leave employment is inappropriate. Proposals now include that amounts in retirement accounts at the date of implementation of the legislation, called “P-day”, and growth on these, can be taken in cash, but from a preservation fund, and subject to taxation.

After P-day, all retirement funds will be required to identify a preservation fund and transfer members’ balances into that fund, or another preservation fund, when members withdraw from the fund before retirement. From P-day, other than a de minimis provision (to be raised from R75 000 to R150 000), pension and provident funds will not be permitted to pay cash withdrawal benefits to any member who withdraws from the fund before retirement.

Existing rules on preservation funds will be relaxed to allow one withdrawal per year, but the amount of each withdrawal will be limited. Preservation fund members will be able to withdraw each year the greater of the state old-age grant (OAG) or 10% of their initial deposit, excluding any portion to which vested rights apply. Any unused withdrawals may be carried forward, but to reduce administrative costs, individuals will be limited to one withdrawal per calendar year or part thereof.

Full vested rights with respect to withdrawals from retirement funds will be protected.

Payments resulting from divorces will also need to be paid into preservation funds rather than being paid in cash.

(See examples provided by Treasury at the bottom of this story, with tables to demonstrate the impact.)

Annuitisation

The annuitisation requirements of provident funds and pension funds will be harmonised.

However, the new annuitisation rules will only apply to new contributions made to provident funds after P-day, and growth on these contributions. Existing balances in provident funds, and growth on these, will not be subject to annuitisation.

In addition, members of provident funds who are older than 55 on the date of implementation will not be required to annuitise any of their balance at retirement, provided they remain in the same provident fund until they retire.

To lessen the impact on provident fund members, the means test for the old age grant will be phased out by 2016, and the de minimis requirement for annuitisation will be raised from R75 000 to R150 000.

Trustees will be required to guide members through the retirement process, to identify a default retirement product in accordance with a prescribed set of principles, and to automatically shift members into that product when they retire, unless members request otherwise. The fund itself may provide the default product, or it may use an externally-provided product.

Living annuities will be eligible for selection as the default product, provided certain design tests, including on charges, defaults, investment choice and drawdown rates, are met. Trustees that make commission-free financial advice available to members on retirement, paid for out of the fund on a salaried basis, will be given some legal protections in respect of the choice of the default. To increase competition, providers other than registered life offices will be allowed to sell living annuities.

Non-retirement savings

Government intends to proceed with the implementation of tax-preferred savings and investment accounts. All returns accrued within these accounts and any withdrawals would be exempt from tax. The account would have an initial annual contribution limit of R30 000 and a lifetime limit of R500 000, to be increased regularly in line with inflation. The new accounts will be introduced by 2015, and will co-exist with the current tax-free interest income dispensation.

With effect from 1 March 2013, tax-free interest-income annual thresholds will be increased from R33 000 to R34 500 for individuals 65 years and over, and from R22 800 to R23 800 for individuals below 65 years. These thresholds may not be adjusted for inflation in future years.

Broader reforms

In addition to the proposals described above, Government is exploring ways to increase retirement fund coverage to all workers. This is a complex issue, given the large proportion of uncovered workers who earn below the tax threshold, who work for small employers, or who have a tenuous connection to the formal labour force, for instance because they work in construction or domestic service.

Examples to illustrate preservation:

Existing member of a provident fund

Brian is a member of the United Workers Union provident fund. His balance on P-day is R400 000. The next day, he resigns from his job. His balance of R400 000 is transferred to the United Workers Union Preservation Fund (UWUPF).

New member after P-day

Themba graduates from high school after P-day. He starts working, and after 5 years, he has accumulated R100 000 in a provident fund. Because he started working after P-day, he has no vested rights. He leaves his job, and transfers his fund to his new employer’s fund. After three years, he has R200 000 in his new employer’s fund. He leaves that job, too, and his R200 000 is transferred to the Life Company Preservation Fund (LCPF). At that point, the old age grant (OAG) equals R23 000 per year.

Since he has no vested rights, in the first year, he may withdraw the greater of R23 000 or 10% x R200 000, which is R20 000. He cannot find another job, so he withdraws R23 000 immediately. This leaves R177 000 in the LCPF. A year later, this has grown to R190 000. The OAG is R24 000 per year. He withdraws R24 000, leaving R166 000 in his account. A year later, this has grown to R185 000, and the OAG is R25 000 per year. He withdraws R25 000, leaving R160 000 in the account. He finds another job, and makes no further withdrawals until four years later, when he withdraws the maximum permitted R110 000.

Existing member of an umbrella fund

Busisiwe is a member of the Consolidated Umbrella Fund. On P-day, her balance in the fund is R450 000. Two years after P-day, this balance has grown to R500 000. Contributions she made to the fund after P-day, and growth on these, are worth an extra R100 000. Her total balance is therefore R500 000, which represents her vested rights portion, plus R100 000, which equals R600 000.

At this point, she leaves employment. Her balance of R600 000 is transferred to the Consolidated Preservation Fund (CPF). At any time, she may withdraw R500 000 from CPF. In addition, for each year she stays in CPF, she may withdraw the greater of the OAG, or 10% of R100 000. She chooses not to withdraw any money immediately.

After 5 years, the R600 000 deposit in CPF has grown to R1 000 000. At this point, the OAG equals R22 000 per year. She may now withdraw R500 000, plus the greater of 5 years x 10% x R100 000 or the sum of the OAG over the 5 years, which is R117 000.

She decides to take out R350 000. This leaves R650 000 in CPF.

Three years later, this R650 000 has grown to R850 000. At this point, the OAG equals R25 000.

Now, she may withdraw at most R500 000, plus the greater of 9 years x 10% x R100 000 or the cumulative sum of the OAG, less the R350 000 she has already taken out. This equals R339 000. She withdraws R339 000 to help pay for a new car. This leaves R511 000 in the fund. Four years later, this R511 000 has grown to R700 000. At this point, the OAG equals R28 000.

Now, she may withdraw at most R500 000, plus the greater of 14 years x 10% x R100 000 or the sum of the OAG, less the R689 000 she has already taken out. This equals R81 000. She elects to make no further withdrawals.

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