Three things to know about retirement reform

Regulations to harmonise the tax treatment of retirement fund contributions are set to be introduced from March 1 next year, but questions remain about whether the reforms will really encourage household savings and improve the plight of vulnerable individuals.

This article looks at three of the changes and their broader ramifications.

1. Provident funds compelled to annuitise two-thirds of pension, but only once a R247 500 threshold is reached

From March 1 next year all new contributions to provident funds by those younger than 55 will be subject to the two-thirds annuitisation requirement at retirement (provident fund members will only be able to take one third of their pension benefit as a cash lump sum and the remaining two thirds will have to be annuitised), but only once a member’s retirement savings exceed R247 500. The previously proposed threshold was R150 000.

Provident fund members could previously take their full pension benefit as a cash lump sum at retirement.

In a Question and Answer document released by National Treasury, it emphasises that the reforms do not take away the right of provident fund members to take their benefits before or at retirement.

“Instead, the reforms enable a slower use of such benefits in retirement by requiring annuitising from a certain amount. The data indicates that 83.5% of provident fund members earn R160 000 or less, and that the majority of these retire with an average retirement benefit of R300 000 or less,” it said.

Gavin Came, director of the Financial Intermediaries Association of Southern Africa (FIA), says the increased threshold of R247 500 probably reflects the vast majority of the member pension accounts administered by the various pension administrators.

As a result, a significant number of provident fund members would not be required to annuitise.

“From this point of view the financially vulnerable people are not protected at all,” he says.

Came says it seems the measures are going to force annuitisation on relatively wealthy savers who may, as a result, be less inclined to commit savings to these funds.

“What we should have done is allow people to draw lump sums after they had sufficient accumulated capital to secure, say, a R1 500 per month escalating pension,” he argues.

In other words, South Africans should have been compelled to preserve the first, for example R200 000 of their pension, and only be able to draw lump sums after that. However, unions would have rejected such a proposal, he says.

But says Kobus Hanekom, head of strategy, governance and compliance at Simeka Consultants and Actuaries, on average South Africans don’t earn a pension of much more than 25% of their last salary in retirement (the net replacement ratio).

For people who need to live off 20% off their final salary, taking an annuity will not be that helpful. For South Africans who have a relatively small pension, it may be better to access the lump sum at retirement and to buy a house, vehicle or cows and to generate an income in their old age, he adds.

While the current situation is not perfect, on the whole South Africa is moving in the right direction, but it will take a number of years to reach a point where most South Africans have set aside appropriate amounts of money to sustain their lifestyle in retirement, Hanekom says.

2. The tax deduction for retirement contributions is increased to up to 27.5% of the greater of taxable income or remuneration

Came says while he would advise individuals to utilise the opportunity to increase their contributions, most vulnerable South Africans are struggling to get to 15% and would not be able to reach 27.5%.

Hanekom says the average lower income South African is highly indebted and even though they may want to contribute more towards their retirement savings, they simply can’t.

To improve the current savings scenario will be a process, which will take a number of years, he adds.

However, Hanekom expects that a significant portion of those South Africans who are not already in a debt trap and who have a better understanding of what it takes to retire comfortably, will contribute more towards their retirement.

3. The tax deduction of 27.5% will be subject to a rand cap of R350 000 per annum

Hanekom says for fund members who earn more than R1.27 million per annum, this will unfortunately not be good news.

These members will be entitled to a tax deduction on contributions of up to 27.5% of their remuneration or their taxable income, whichever is the greater, but subject to a rand cap of R350 000 per annum. This is the cumulative maximum for all retirement fund contributions, he says.

“Higher income earners will therefore have to combine their contributions, including those to retirement annuity funds and decide on a strategy going forward,” he says.

But says Came, over-contributing to a retirement fund (in excess of R350 000) is not such a significant issue, since the undeducted portion of the over-contributions is carried forward to the next year and eventually paid to the individual in the form of a tax-free pension.

“In the meantime, your portfolio has grown totally free of tax,” he says.

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