It’s no secret that the financial planning industry is highly regulated, as it should be – and managing your financial affairs is as much about grasping the numbers as it is about understanding the applicable legislation.
In this article, we explore five pieces of legislation that impact your financial affairs and how they affect your financial planning.
(i) Section 37C of the Pension Funds Act
If you’re contributing towards an approved retirement, it is important to understand the impact of Section 37C of the Pension Funds Act, specifically the extent to which it affects your succession planning. If you’ve been contributing towards a retirement fund for most of your life, these funds are likely to form a large portion of your wealth.
When developing your estate plan, keep in mind that your retirement fund benefits fall outside of your estate and within the ambit of the Pension Funds Act. Section 37C of this Act regulates the distribution and payment of lump-sum benefits payable on the death of a member of a pension, provident, preservation and retirement annuity fund. Practically, this means that if you die before you retire from the fund and a lump sum is payable on your death, the trustees of the fund have a duty to allocate and pay the benefits in a manner that it deems to be fair and equitable. So, while you can indicate who you would like the funds to be paid to on your beneficiary nomination form, ultimately the decision rests with the trustees of the fund whose decision will be guided by identifying those who are either wholly or in part financially dependent on you. As such, your beneficiary nomination will be used by the fund trustees as a guide only meaning that there is no guarantee that your funds will be allocated in line with your intentions.
Remember, the primary reason that government provides significant tax benefits for retirement fund investors is to encourage South Africans to save for their retirement years, thereby reducing the burden on the state. Thus, in the event of your premature death, Section 37C ensures alignment with the government’s intention by ensuring that your financial dependants are provided for.
In exercising their duty, your retirement fund trustees will conduct an investigation to determine who is financially dependent on you, irrespective of whether or not you were legally required to maintain them. Your ‘financial dependants’ can include children, parents, grandparents, spouses, life partners, same-sex partners, step-children, foster children and even unborn children, and anyone else who your trustees determine relies on you for financial support.
How does this affect your financial planning? Your retirement fund benefits do not form part of your deceased estate and therefore should not be mentioned in your will as this can only cause confusion. As these assets fall outside of your estate, they can be used effectively to reduce your estate duty liability and executor’s fees. However, when structuring your estate plan, don’t lose sight of what Section 37C means in terms of distributing your assets equitably amongst your heirs and beneficiaries. Make sure that your will deals adequately with those assets that fall within your estate, and that the beneficiary nominations on your life policies are correctly structured.
(ii) Section 18A of the Income Tax Act
If you make donations to charitable organisations, be sure that your charity is an approved Section 18A Public Benefit Organisation (PBO) so that you can get a tax deduction on your donation. In terms of the Income Tax Act, individuals can donate up to 10% of taxable earnings towards an approved PBO on a tax-deductible basis, but to receive the tax exemption, you need to ensure that the non-profit is duly registered with Sars and that the tax exemption is approved by the Sars Tax Exemption Unit (TEU). If approved, you can claim a tax deduction if you are in receipt of a Section 18A certificate issued by your PBO.
In order to become an approved PBO, the company, trust or association must have been incorporated, formed or established in South Africa. If you are donating to a charity, it is important to understand the difference between a PBO and a non-government organisation (NGO) that is not an approved Section 18A institution. While a donation to an approved PBO has tax benefits, donations to an NGO are not tax-exempt and may in fact attract donations tax if you exceed the annual threshold.
How does this affect your financial planning? Before making any donations, do your research to find out whether the organisation you intend to donate to is a Section 18A approved organisation. To claim your tax deduction, upload your Section 18A certificate when doing your eFiling, ensuring that the certificate includes the PBO’s reference number, date of receipt of the donation, the name and address of the donor, and the amount or nature of the donation.
(iii) Definition of spouse
If you live together with your life partner but are not legally married in terms of South African law, it is important to know that the definition of what constitutes a ‘spouse’ differs depending on the applicable legislation. Let’s take, for example, the Medical Schemes Act which recognises your cohabiting partner as an adult dependant on your medical aid regardless of your marital status. For tax purposes, the Income Tax Act determines that a spouse includes ‘a same-sex or heterosexual union which the Commissioner is satisfied is intended to be permanent. Falling within this definition means that the donations tax exemptions apply to you and your life partner, as does the Section 4q estate duty abatement. Further, if your life partner bequeaths immovable property to you, in the event of their death you will not be liable for transfer duty.
As life partners, you are free to nominate your partner as a beneficiary of any domestic life policy. In the event of your death, the proceeds of the policy will be paid directly to your partner and, as you fall within the definition of ‘spouse’ for tax purposes, the proceeds will not be considered deemed property in your estate and will not attract estate duty.
On the other hand, there are several important pieces of legislation that take a stricter view on what constitutes a spouse, such as the Divorce Act, the Marriage Act, and the Maintenance of Surviving Spouses Act. For instance, the right to claim a share of your member spouse’s pension interest is limited to those couples who are legally married. Partners to a legal marriage have the right to claim against the member spouse’s retirement fund for their share of the pension interest, which is the total benefit the member would have been entitled to if their membership ended due to resignation at the date of divorce.
Another consideration is that a legal marriage creates what is referred to as a duty of support. which is not the case when it comes to cohabitation. If your life partnership comes to an end, there is no legal obligation on either partner to provide the other with any form of maintenance or financial support. Similarly, where the Maintenance of Surviving Spouses Act provides a mechanism for surviving spouses to claim against the estate of their deceased spouse to the extent that their spouse failed to provide for them financially, no such mechanism is available for the surviving partner in a cohabiting relationship.
How does this affect your financial planning? While cohabitation may be more flexible and less regulated, it is important to mitigate against the financial risks endemic to such relationships. While you may enjoy the same tax benefits as legally married persons, keep in mind that no duty of support exists between you and your partner – both while you are alive and after death. It is always advisable to put a cohabitation agreement together which sets out the financial implications of your union, specifically dealing with the financial consequences of termination of the relationship.
(iv) Taxation Laws Amendment Bill
The latest Taxation Laws Amendment Bill, which includes changes to the laws that govern provident and provident preservation funds, came into effect on 1 March 2021 in terms of which the rules of all retirement funds were brought into sync – the idea being to create a uniform retirement fund system across all types of retirement funding vehicles.
Prior to 1 March 2021, members of a provident or provident preservation fund were allowed to take 100% of their retirement benefit as a lump sum on retirement, subject to the applicable taxation on the non-tax-exempt portion. On the other hand, members of pension or pension preservation funds and retirement annuities are only permitted to commute one-third of the retirement benefit in cash at retirement, with the remaining two-thirds being used to purchase an annuity income.
From 1 March last year, provident funds are subject to the same rules at retirement as pension funds and retirement annuities, except whereas a provident fund member you were age 55 or older at that date and you remain a member of the same provident fund. As an existing provident fund member, all your accumulated funds as at 28 February 2021 have been given ‘vested rights’ and have not been impacted by the harmonisation legislation, meaning that at retirement you will be able to withdraw 100% of your retirement funds provided that you remain a member of the same fund. However, if you transfer your benefits to another fund, you will retain ‘vested rights’ on the interest accumulated until the date of transfer from the old fund, including all subsequent growth. Any contributions to your new fund plus any growth on those contributions will be subject to the new annuitisation rules.
If you were a provident fund member and under the age of 55 as at 1 March 2021, this legislation will only affect new contributions made from 1 March onwards. All contributions and growth on those premiums made prior to this date will receive the vested rights.
How does this affect your financial planning? If you were age 55 or older on 1 March 2021, remember that you will be able to commute up to 100% of your provident fund benefits at retirement provided that you have remained a member of the same fund. If you were under the age of 55 at that date, you will be able to commute 100% of your vested rights, while the provident fund benefits that accrue post-1 March will be subject to the new annuitisation rules.
(v) Regulation 28 of the Pension Funds Act
Regulation 28 is part of the Pension Funds Act with its purpose being to protect investors against poorly diversified investment portfolios by ensuring that investors do not take on too much risk in their portfolios. This piece of legislation, which is applicable to pension, provident and retirement annuity funds, limits asset managers’ allocations of retirement savings to certain assets classes, including equities, property, and foreign assets. As it currently stands, Regulation 28 limits equity exposure in retirement funds to 75% whether local or offshore. Exposure to local or international property is limited to 25%, while foreign investment exposure is limited to 30%. There are also additional sub-limits for alternative investments and the percentage of a portfolio that can be held offshore, among others.
However, during his budget address to parliament in February 2022, Finance Minister Enoch Godongwana noted that amendments to Regulation 28 would be published in March. The Budget Review document announced that local pension and savings funds may invest up to 45% of their capital offshore, which is inclusive of the 10% allowance for investments into other African countries. Whereas previously, funds could only invest 30% of their portfolio outside Africa, the proposed amendment would mean they can now invest up to a maximum of 45% outside of South Africa.
While these regulations may seem restrictive, it is important to keep in mind the significant tax benefits of investing through an approved retirement fund, and these benefits need to be weighed against the diversification limits imposed on Regulation 28 compliant funds. In addition, keep in mind that investor behaviour and investment fees can also detrimentally impact your investment returns, so avoid viewing Regulation 28 in isolation. The fact remains that a retirement fund remains a highly tax-efficient investment vehicle and an excellent way of locking your retirement savings in until the minimum withdrawal age of 55. This mechanism in itself helps guard against making knee-jerk, spur-of-the-moment investment decisions, allowing your money to enjoy the benefits of compounding over a longer period of time.
How does this affect your financial planning? There are many ways to build diversification into your investment portfolio, and obtaining offshore exposure through one’s discretionary investment vehicles is now easier than ever before. That said, it is essential to take a holistic view of one’s overall investment portfolio to ensure that it is appropriately structured to minimise tax, optimise investment returns, ensure liquidity, and mitigate against unnecessary risk.