Preparing for T-Day
By Richard Tyler, Managing Director, Simeka Consultants and Actuaries
In December 2014, the state president approved the Taxation Laws Amendment Act, 2013. Employers and retirement funds therefore have just more than one year to make adjustments in preparation for T-day which will be on 1 March 2015.
- The tax deductibility of contributions to pension, provident and retirement annuity funds will be harmonised and every member will be entitled to a deduction of 27.5% of remuneration or taxable income (excluding retirement lump sum and severance benefits). This will be up to a maximum of R350 000 per annum. Employer contributions will continue to be deductible for the employer but the new controls will aggregate and assess the total allowable deduction in the hands of the member.
- New contributions to provident funds will be subject to the same rules as pension funds i.e. a maximum of one third of the retirement benefit can be taken in cash and the rest must be annuitised. All existing lump sums (as at T-day) and the growth thereon will be protected into the future – whether in the existing provident fund or in another fund.
Consolidate hybrid funds One of the high level decisions that employers and retirement fund trustees should make in preparation for the financial regulations changes relating to T-day is whether or not to consolidate pension and provident funds where they operate as a hybrid arrangement. In the past, the best of both worlds could be achieved by investing member contributions in a pension fund (allowing maximum tax deductibility) and investing employer contributions in a provident fund (allowing lump sum benefits at retirement).
From T- day, pension and provident fund contributions will be taxed in exactly the same way and all new contributions to provident funds will, upon retirement, be subject to a maximum lump sum benefit of one third and the compulsory annuitisation of the balance.
Running both funds, at almost double the cost of a single fund, will therefore have no further advantage and it would make sense to consolidate them.
In view of the special requirements introduced to protect vested lump sum benefits of especially members of 55 years and older in provident funds, it appears easier to transfer the members of the pension fund to the provident fund. It may also be advisable to review the name of the provident fund at the same time.
Communication: tax harmonisation It will be beneficial to communicate the tax harmonisation measures to members during 2014. In addition, the general member communication and information material will have to be amended. Changes to provident fund information material will be more significant.
Projected pension ratio calculations In view of the changes to the tax deduction formulas we encourage employers and funds to express contribution rates as a percentage of remuneration – as well as a percentage of pensionable salary (PEAR). At present, contributions are almost exclusively expressed as a percentage of PEAR. The concern is that although PEAR is typically 80% of remuneration, many employers allow members to elect a lower PEAR in order to secure a bigger take home pay. When this happens PEAR is not a meaningful number and may provide members and trustees with a false sense of security. In the event of death or disability for example, a 50% PEAR will provide a benefit of 3 times PEAR but that will only amount to 1.5 times remuneration – which is the amount that really matters.
Taxation of disability income policies From 1 March 2015 premiums paid by natural persons in respect of life, disability and severe illness policies (including disability income benefits) will no longer be deductible, even if the policies are aimed at income protection. The pay-outs will be tax-free. Employees will as a result be taxed on any premiums paid by the employer and no subsequent deductions will be available. Employers will have to adjust their payrolls accordingly and manage the cash flow concerns of affected members. Because there is no transitional period, even existing disability income payments will no longer be taxed from 1 March 2015.
Benefit Structure: default strategies Another high level consideration, in the context of the changing new environment, created by the retirement reform measures is the implementation of a default contribution rate, a default preservation fund, a default investment strategy and a default annuitisation strategy. These defaults should be aimed at securing a good retirement outcome for members in alignment with the retirement reform proposals made by National Treasury.