The proposed tax changes that may affect employee benefits look to take effect only in 2013. Announcements were made in the Budget speech, while at this stage there is no draft bill; there is a clear indication from National Treasury of the changes that may well take place, according to Andy Clark, Head of Benefit Consulting at Liberty Corporate Consultants and Actuaries. Clark offers some insights as to what employees can expect with respect to their benefits.
1. The state will work towards giving the employee less flexibility around managing their savings in provident funds at retirement, suggests Clark. “Employees will most likely be forced to take out an annuity with at least two thirds of the fund value, with the one third balance being available for cash”. By structuring the funds at retirement in this way, the employee is provided with some continued income during their retirement years. The ability to encash the full savings earned to date will still remain, which means no need to panic with rights attached to current benefits.
As Clark points out, South Africans do not follow a strong culture of saving. What often happens is people receive a lump sum payout and tend to spend the total amount, leaving them reliant on the state during their retirement years. “Government wants to encourage responsible money management amongst the population, therefore easing the burden on the state,” explains Clark.
2. As the law currently stands, contributions by employers to pension or provident funds are still tax deductible up to 10% of his employees’ retirement funding income (in practice up to 20% is allowed without question) in addition to 7.5% deductible as member contributions to pension funds. A further 15% of non retirement funding income is deductible if paid to a retirement annuity. There is a need to equalize the treatment of pension and provident fund and remove the retirement funding income distinction. “As announced by the Minister of Finance in his budget speech this year, the proposal is that tax deductibility be taken away from employers and shift to employees, at around 22.5% of taxable income, with a ceiling of R200 000 per annum,” says Clark. Where clarity is also required is where costs like administration fees and insured death/disability benefits are implied. It is uncertain whether these will shift to the employee over and above the 22.5% rate. This is obviously a concern in terms of how defined benefit funds will be treated where the employer pays the balance of costs.
The question then is whether it will still be attractive for employers to arrange for a group scheme to be implemented. “Absolutely,” confirms Clark. “Operating costs will almost certainly be less than individual retirement initiatives, thereby possibly resulting in a greater proportion of the employees’ contributions being allocated to retirement funding. Under certain Funds, however, the benefit could simply be lower fees, but that would mean more money in the employees’ pockets. There are also likely to be cost savings because on group risk schemes there is often one group aggregate cost that is probably more attractive than individual rates, particularly for older members.” No underwriting (restriction) of benefits applies up to a high salary level (free cover limit) in group schemes which is beneficial to the few individuals in a company who may be able to access insurance at affordable rates. “Under a group scheme, members will always be covered for whatever the free cover amount is as a limited benefit value. This is an added incentive for employers to maintain group schemes,” says Clark.
By the same token, the onerous burden of the administration process is taken away from the individual if an employer manages their scheme. The employer’s role remains key even though the model is shifting towards the employee. “The shift is essentially for tax efficiency purposes,” says Clark. “So it’s important that one continues with the group scheme for all the abovementioned reasons.”
3. Whilst not discussed in the Minister of Finance’s speech earlier this year, the National Treasury’s papers on Social Security and Retirement Reform do discuss the possibility of the compulsory preservation of benefits. The new legislation may cover this matter and may also allow consumers’ partial access to their retirement funds should they satisfy certain ‘emergency’ criteria. But who and what determine an emergency? Clark says this would refer to situations where a person needs urgent access to funds in an emergency situation, for example if they were to be compulsorily retrenched. “There’s little point in keeping funds inaccessible if it’s required,” he says.
Regulation 28 – what does this mean for the industry?
“Regulation 28 in fact already exists and prescribes the prudential investment of retirement funds to certain types of assets. The regulation also specifies what those limitations per asset type are,” says Clark. The revisions to the regulation were required due to the complex financial structures available to consumers nowadays; far more intricate than say ten years ago. Legislation was required to manage these structures and revised Regulation 28 introduces key principles to assist trustees in the decision-making process. These include compliance, the requirement for each fund to have an investment policy statement, education (to trustees and members), monitoring of compliance, insuring that assets are appropriate for liabilities, due diligence (local and offshore managers, assets, instruments), understanding the changes in risk profile of liabilities and consideration of factors that may affect long-term performance.
4. Most importantly, the new Regulation 28 requires compliance at a member level, whereas previously this was at an aggregate fund level.
Clark says in the future each fund will require a documented investment policy statement. “Effectively this would be a statement by the fund itself outlining how money is being invested amongst other matters.” Where compliance was not previously required by law, now it will be, meaning tighter legislation and therefore far better protection for the consumer. “The proposed regulation highlights the fiduciary duty of trustees to act in the best interest of members by ensuring a responsible investment approach and sustainable long-term performance of its assets. It will be imperative that Trustees seek expert advice as regards the investments of the Fund where they may lack sufficient expertise”, says Clark.
“The regulation will hopefully ensure savings are invested in a prudent manner, thus safeguarding the assets with an acceptable level of risk. This complements the tighter controls already mentioned.
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