Demystifying Retirement Funding
Let’s try to break this all down into phases of your life, and look at the various terms which will apply to those phases.
PRIOR TO RETIREMENT
PENSION FUND ARRANGEMENTS FOR EMPLOYEES BY THE EMPLOYER
The provision of substantial income after retirement is a widespread feature of employment in South Africa today.
Despite the skeleton State Pension Benefits available, the responsibility for providing pensions for all employees rests firmly on the shoulders of the employer. Whatever method is adopted for discharging this obligation, employees will naturally hold the employer primarily responsible for the overall quality of the benefits they receive. However, each fund is tailored to the requirements of the employer/employee relationship.
Benefit design is the way in which various Employee Benefits such as pension, provident, death and disability benefits are brought together to provide the individual employee with a comprehensive benefit which fulfils his real needs. A specific benefit structure can only be applied to a group of people within a fund but the actual needs of individuals will differ. This has to be borne in mind when considering the following underlying principles:
• Value for Money
It is important that there is sufficient use of available financial resources. The company has limited funds which can be allocated to employee benefits, and it is necessary to ensure that these are utilised effectively to address employee’s real needs. The company is also likely to want employees to realise, from the quality and effectiveness of their benefits, just how much the employer is doing for them.
Fair treatment between employees is fundamental to a pension/provident scheme operation, and is enforced to a degree by law. Equity does not mean that all employees in the fund should be treated identically, but that they should be dealt with fairly according to their circumstances. For example, it is quite in order to place all executives in a category which enjoys different benefits than other categories, but it would be unfair and illegal to name certain of these executives for further benefits not enjoyed by others in that category.
• Relation to Real Needs
The funds benefits are designed to provide for different occurrences during an employees association with the company. It is therefore logical to arrange benefits so that they fit in naturally with the changing needs of the employees.
PENSION and PROVIDENT FUNDS
Both pension and provident funds must be registered in terms of the Pension Funds Act of 1956.
The main difference between pension and provident funds is:
• Under a pension fund a maximum of one third of the capital may be taken as a cash payment and the balance of two thirds of the capital at retirement must be paid as a pension for the rest of the pensioner’s life.
• Under a provident fund, the full capital at retirement may be taken as a lump-sum cash payment.
Any cash taken at retirement is taxed.
This falls under the pensions act, and is regarded as a “private” pension fund that anyone can take out to supplement his or her pension or provident fund.
TAXATION PERTAINING TO RETIREMENT FUND CONTRIBUTIONS
As at 1st March 2016 new rules were introduced in respect of the tax deductibility of retirement fund contributions made by employers and employees/fund members. The amendments were introduced in the Taxation Laws Amendment Act of 2013.
With any new legislation, interpretation can differ as there are always grey areas open for debate and unfortunately, only the practical workings of the legislation will bring clarity (in most instances).
All contributions made by an employer on behalf of an employee to a pension fund, provident fund or retirement annuity fund, will qualify as a tax deduction for the employer in terms of section 11(l) of the Income Tax Act (the Act). No limit is imposed on the tax deductible amount. Therefore, whatever the employer contributes on behalf of an employee will be tax deductible (unless SARS deems the contribution to be excessive, in which case it can be limited or disallowed).
Employee/fund member contributions:
Individual taxpayers will be entitled to deduct all contributions made to retirement funds – including pension, provident and retirement annuity funds, and including those contributions made by the employer on their behalf (as long as the contributions were included in their gross income as a fringe benefit) and it is less than or up to the prescribed limits (see below).
In terms of section 11(k) of the Act, the employee will be entitled to a tax deduction equal to 27.5% of the greater of:
– Remuneration as defined in paragraph 1 of the Fourth Schedule (which excludes any retirement fund lump sum benefit, retirement fund lump sum withdrawal benefit or severance benefit for the purposes of determining the maximum deductible contribution), or
– Taxable income (which excludes any retirement fund lump sum benefit, retirement fund lump sum withdrawal benefit and severance benefit) as determined before allowing any deduction under this paragraph.
An overall monetary cap of R350 000 will apply per annum. This cap will be reached where a taxpayer contributes the maximum 27.5% and the higher of remuneration or taxable income is equal to R1 272 727. Where the contribution rate is below 27.5%, the monetary value of the maximum remuneration or taxable income will increase accordingly – for example – if the taxpayer is only contributing 20% to a retirement fund, the maximum taxable income or remuneration will be equal to R1 750 000.
The deductible contributions include the portion of the contribution allocated to an approved group life benefit, administration costs that include commission and investment advice fees. It does not include premiums paid in respect of unapproved group life benefits.
This slots in between all of the above, and only becomes relevant should you elect to leave the company or become retrenched BEFORE retirement age 55. It is simply an extension or continuation of your pension or provident fund.
Note that at this juncture in your life (leaving the company etc), you are entitled to either cash in your pension or provident fund, which will be fully taxable (after the first R 25 000 is deducted) in your hands OR you can transfer the funds, free of tax, into a preservation fund. This fund allows you access of up to 100% of your funds ONCE between the time you invest into the preservation fund and retirement age.
A very important note regarding this “accessibility” – many advisors/brokers will recommend that you take the R 25 000 tax free portion and transfer the balance into a preservation fund. This will negate the accessibility, as the receiver deems that R 25 000 to be your one draw – be aware !
Once you have reached this magical age (and in today’s age of health care, it is still a wonderful age, so enjoy it!), a whole myriad of options open up for you, and the decisions become quite critical. We need to look at these in depth.
PENSION FUNDS and RETIREMENT ANNUITIES
Should the retirement benefit value be less than R247 500, you are not forced to purchase an annuity and therefore allowed to commute the full capital.
A pension fund allows you to withdraw up to 1/3 of the fund value in cash. This sum will have a portion that is tax free. For now that portion is R500 000 for all pension products on retirement. Once you have extracted this “cash” portion, you can obviously do with it as you please.
However, for the balance of 2/3, you HAVE TO purchase an ANNUITY of some sort – not to be confused with the RETIREMENT ANNUITY into which you may be paying a monthly premium!
This is where the problems creep in – not many people are aware of the variations within the term “Annuity” and the problem is that, once committed, you cannot change your mind! It is thus imperative that you know what you are buying up front. Herewith a few definitions:
NIL GUARANTEE LIFE ANNUITIES
Bought from an insurance company. Secures a GUARANTEED income for the life of the annuitant, and ceases on their death with NO further benefits for spouse or heirs (lose the capital). Generally will pay the highest income. Only really applicable to those who have no dependents or need to support anyone else;
5/10/15 YEAR GUARANTEE AND LIFE THEREAFTER
Bought from an insurance company. Will pay a guaranteed income for the guaranteed period selected (5, 10 or 15 years) should the annuitant die before that period expires. Will cease upon death of the annuitant AFTER that period with no further benefits for heirs. Income is affected by the length of the guarantee;
Bought from an insurance company. Same as a Nil Guarantee Life Annuity above, however, part of the annuity income pays a life policy which will insure the capital, thus allowing the heirs to receive the original capital sum upon death of the annuitant;
A ‘Living’ Annuity allows the capital to be invested and managed by the annuitant (investment advisor), from which he/she can select their own level of income between 2.5% and 17.5% of the capital sum per annum. Probably the best option IF the capital is wisely invested and IF the annuitant selects his/her income at a prudent level (recommended at no higher than 5% per annum);
We stress that it is imperative that you obtain quotes and review ALL the options. We at Brantam tend to lean towards the LIVING ANNUITY as this does have the facility of preserving the capital for your heirs and offers the annuitant flexibility in income choices, but it all needs careful consideration before committing.
One of the so-called “plusses” of a provident fund is that the full value can be commuted as cash at retirement, without being stuck with the 1/3 – 2/3 rule. The issue here is that you pay tax on this cash portion, and then still have to find ways to re-invest the funds so as to generate a monthly income.
The recommendation is to rather look at transferring the fund value into one of the above mentioned annuities free of tax the same way as you would a pension fund.
As mentioned, a preservation fund is really a continuation of your pension or provident fund, and will thus be treated the same as for those products.
This has been a rather long winded diatribe on retirement funding, but a very important one. No-one expects you to remember all of this (that is what we are here for), but it will hopefully provide you with a clearer insight into the pitfalls which may present themselves. Print it and keep.
* * * HAPPY RETIREMENT ! * * *