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First Steps to Retirement Reform

12 August 2013

Routledge Modise

Following a series of discussion papers on retirement reform, the National Treasury released the draft Taxation Laws Amendment Bill, 2013 for public comment on 4 July 2013.

As a first step to the proposed retirement reform, the Treasury, through the proposed amendments to the Income Tax Act 58 of 1962 (to be effective 1 March 2015), seeks to address the policy concerns of the notoriously low preservation levels associated with withdrawal benefits accruing to members of pension and provident funds, and specifically the ability of provident fund members to access their full benefit as a lump-sum on retirement. The ability of a retiring provident fund member to accrue a lump-sum allows them to spend it immediately which increases the risk of the state having to assist the now impoverished former member.

Treasury, in its discussion paper Preservation, Portability and Governance (21 September 2012), proposed several measures to address the leakage of retirement savings. These measures include, among others, mandatory preservation on resignation, and mandatory annuitisation on retirement.  

Conceptual difficulties exist in the alignment of the taxation of pension and provident funds, these being the ability of pension fund members to claim a deduction (7.5% of "retirement-funding employment" income) in respect of contributions made to a pension fund. No deduction is claimable by members in respect of contributions made to a provident fund. The industry has circumvented this issue by making only the employer contribute to the provident fund, on a salary sacrifice basis. To further complicate the taxation of retirement funds, transfers of members' benefits between pension funds and provident funds are fully taxable as a withdrawal benefit in the hands of the member. It accordingly comes as no surprise that Treasury is seeking, through the enactment of the Bill, to harmonise the tax treatment (employer and member contributions and withdrawals) of pension and provident funds.

Among other things, the Bill provides that all contributions made by employers to pension and provident funds will be taxed as a fringe benefit in the hands of the employee, allowing the employer a full deduction equal to the cash equivalent of the fringe benefit. In turn, members will be entitled to claim a deduction in respect of contributions made equal to 27.5% of the greater of "remuneration" and "taxable income" and capped at R350 000, such cap providing a disincentive to wealthier individuals to contribute to pension and provident funds. The term "taxable income" is included to cater for contributions made by self-employed individuals to retirement annuity funds.

A layer of complexity is added in the valuation of the cash equivalent of the fringe benefit accrued to employees. In this regard, the cash equivalent of the fringe benefit paid by employers contributing to defined contribution funds will be equal to the actual expenditure incurred by the employer, and, in respect of contributions made to defined benefit funds, equal to, conceptually, the increase in the member's interest as a result of the member being employed for one further period. The cash equivalent of fund-provided risk benefits (i.e. disability and group life insurance) is equal to the actual expenditure incurred by the employer.

Furthermore, provident fund members will now be required (in respect of non-vested benefits as at 1 March 2015) to utilise at least two-thirds of their benefits on retirement to purchase an annuity. To protect historic vested rights it has also been proposed that provident fund members, over the age of 55 years as at 1 March 2015, will be exempt from these provisions should they remain a member of the same provident fund until retirement.      

The proposed amendments cast doubt over whether Treasury has in fact achieved what it set out to do, that is creating a simpler and harmonised tax regime for retirement fund organisations. The valuation of the fringe benefit accrued, as well as the proposal to protect historic vested rights, may prove to be difficult in practice, placing an additional obligation on administrators and defined benefit fund valuators alike. This, in light of Treasury's concomitant concerns relating to the costs associated with fund administration, may appear to be counter-productive.

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