This article was first published in the first-quarter 2016 edition of Personal Finance magazine.
Recent and planned changes in tax and retirement law will have a significant impact on how you plan and structure your retirement.
The changes will influence:
* How much you can save for retirement using tax-incentivised products;
* When you actually retire (stop work), as opposed to your official retirement date;
* How you preserve your tax-incentivised retirement savings when you change or lose your job;
* Whether you allow your retirement fund’s trustees to make decisions for you on underlying investments before and during retirement; and
* What form your retirement income will take and what investments should generate that income.
John Anderson, the head of research and product development at retirement fund administrator Alexander Forbes, says that many of the changes are being driven by retirement reform, which has been under way for a number of years; tax reforms, which have been introduced and are due to be implemented; and the government’s so-called “twin peaks” policy to separate the prudential regulation of financial institutions from the market conduct of financial institutions – in other words, separating the risk of your bank or life assurance company going bankrupt from the risk that you will be sold an inappropriate financial product. The proposed legislation was published for comment in October 2014.
Anderson says you need to know about the legislative and regulatory changes that have been made, and what is in the pipeline, because many financial institutions are already making changes in anticipation of what the regulations will require.
For example, National Treasury has signalled that it looks with displeasure on asset managers’ performance fees, so many asset managers are changing their fee structures. But, Anderson warns, the removal of performance fees could see an increase in base asset management fees. The effect may be an overall increase in fees during periods of adverse market conditions, when asset managers would earn no performance fees.
Anderson says the changes will be far-reaching and will require ongoing advice if you are to get the best benefit.
Kobus Hanekom, a pension fund lawyer and head of strategy, governance and compliance at Simeka Consultants & Actuaries, says the decisions you make to accommodate changes and proposed changes to legislation will have a significant impact on how much money you have in retirement.
He says the companies that provide products and services to retirement funds, as well as the funds themselves, are adapting to what is likely to happen. Many retirement funds, particularly commercial umbrella funds, have already started implementing some of the proposed changes, and you will need to take these into consideration when making retirement planning decisions.
Anderson says the changes are aimed at promoting better outcomes for you. For example, the government wants members of umbrella funds to have a greater say in how their funds are managed, it wants to prohibit rules that may compel a fund to use a specific product or service provider, and it wants simpler products and improved transparency on costs, so that it is easier for you and your fund to make valid comparisons.
Underlying the reforms in market conduct is the outcomes-based Treating Customers Fairly regulatory regime (see “Fair-treatment principles”, below).
The key decision areas for you will be:
TAX CHANGES
Tax changes implemented on March 1, 2016 have changed how you deduct retirement fund contributions from your taxable income, as well as how much you can deduct.
Hanekom says that, for most members, the total contribution by both you and your employer to a stand-alone, employer-sponsored or umbrella retirement fund, in terms of the rules of the fund, will not decrease as a result of the change. Instead, you have the flexibility to increase your tax-deductible contributions to 27.5 percent of the greater of your total taxable income or remuneration, to a maximum of R350 000 a year. Contributions by an employer will be added as a fringe benefit and then deducted. The limits include the premiums on group life assurance that are part of your retirement fund package.
The 27.5 percent of taxable income or remuneration equals the current maximum contributions to a stand-alone or umbrella pension fund that individuals (7.5 percent) and employers (20 percent) are allowed to deduct from taxable income.
The 2015 Sanlam Benchmark Survey of employee benefits shows that average employer contributions in 2014 were about 11 percent of pensionable salary, and members contributed, on average, about 6.5 percent, making a total of 17.5 percent. However, a portion of the employer’s contribution (about three percent) pays for the cost of managing your fund and group life assurance premiums.
Before the change implemented on March 1, the contributions paid by you and your employer were typically a percentage of your pensionable remuneration (normally your basic salary excluding any allowances). Pensionable remuneration is normally 70 to 80 percent of your total income.
Before the change, you could deduct from your total taxable income contributions to a retirement annuity (RA) fund to a maximum of 15 percent of any earnings in excess of your pensionable remuneration.
The 27.5 percent is the total amount you can contribute tax-free to any retirement fund, including an RA.
Hanekom says this means you have to decide:
* The level of your contributions to retirement savings up to the maximums you can deduct; and
* Whether to continue to contribute to an RA to supplement your employer-sponsored retirement savings. You may want to increase contributions to your retirement fund and discontinue or reduce your RA contributions.
Hanekom says before you reach a decision you need to take account of things such as:
* Possible penalties that may be applied for making an RA paid-up. You cannot mature an RA until the age of 55, but you can stop contributing before then. However, penalties of up to 20 percent of your accumulated savings can be levied on life assurance RAs. These penalties do not apply to unit trust RAs or linked-investment service provider RAs.
* Investment strategy. For example, you may want or need a more aggressive investment strategy for your RA, with a higher percentage of assets allocated to equities than you would get in your employer-sponsored retirement fund within the limits of the prudential guidelines.
TAX INCENTIVES FOR PROVIDENT FUND MEMBERS
Hanekom says the tax reforms have resulted in the tax deductions for provident fund members being aligned with those for pension fund members.
Before the change on March 1, provident fund members could not deduct their contributions from taxable income. Employer contributions made on your behalf to a provident fund were tax-deductible for the employer.
As a result of the tax change, provident fund members can deduct contributions against taxable income. At the same time, employer contributions paid on your behalf are included in your remuneration as a taxable fringe benefit. The aggregate of your contributions and those of your employer are tax-deductible up to the limits.
Initial proposals for the tax deductions for provident fund members that were introduced on March 1 included allowing provident fund members to take up to one-third of their retirement savings in cash and compelling them to buy a monthly annuity with the remaining two-thirds. Cosatu was vehemently opposed to this, and the proposal was removed on the understanding that, if provident fund members do not agree to buying an annuity with the bulk of their savings by 2018, the deduction could be removed.
The original proposals contained clauses protecting provident fund members’ vested rights – for example, members could withdraw all they had saved before the annuitisation requirement was introduced after it came into effect.
Vested rights are likely to be protected if provident fund members are obliged to buy an annuity at some stage in the future.
FLEXIBLE RETIREMENT DATE
On March 1 2015, the Income Tax Act was changed to enable you to decide on your retirement date (the date on which you buy a pension with your retirement benefit) as a member of an employer-sponsored retirement fund.
This followed a similar change to the Act in 2008, when the requirement to buy a pension with savings in an RA by the age of 69 years was dropped. This means you can:
* Delay receiving any RA benefit payment to allow your savings to continue to accumulate tax-free growth.
* Use tax deductions for contributions to an RA to reduce your tax liability past the age of 70.
* Use RAs as an estate-planning vehicle. By contributing to an RA, you can reduce both your estate duty and capital gains tax liability by excluding the benefits from your estate and passing them directly on to your beneficiaries, who will pay tax on the benefits at their marginal rate of income tax. Be aware, however, that limits apply, and you should carefully look at how to make use of RA contributions when structuring your estate.
Hanekom says that, before March 1, 2015, you were required in terms of the Income Tax Act to take your retirement fund benefit from your employer-sponsored fund on the day you retired from employment. This date was set in the rules of your fund and employee contract.
He says you now have more flexibility. You will still be required to retire from your job at a certain age, but can now choose to leave your money in the fund and use it to buy an annuity when it suits you. Your benefit will be payable by the fund whenever you elect to receive it.
He says this gives you a number of options when you retire, including the options to:
* Leave your money in the fund where it will grow tax-free, with no additional costs or commissions. You will, however, still pay costs at the same rate as contributing members. Retirement fund rules need to be changed to accommodate this arrangement efficiently. Hanekom says that if you delay drawing a pension from your fund, your savings – using standard assumptions of factors such as investment returns – could double in value in about six years.
* Delay buying a guaranteed annuity. This is particularly important for those who retire when annuity rates are most expensive, in other words, when interest rates are low.
* Mature one retirement savings vehicle, while keeping another invested to boost your pension at a later date.
Hanekom says this means you will have to decide on or take account of:
* The date or dates on which you want to draw your retirement fund benefits; and
* How to use your retirement benefits to best effect for retirement income and estate planning.
Recently, a loophole that allowed the wealthy to use RAs for creative estate-planning purposes was shut. This loophole was created in 2008, when the 69-year age restriction on those who contribute to an RA was scrapped. At the same time, the Estate Duty Act was amended to exclude lump-sum retirement assets from estate duty on death. Pensions were already excluded. This means your estate can escape duty on your retirement savings if you name a beneficiary to receive the proceeds of:
* An investment-linked living annuity or a pension guaranteed to pay out for a fixed number of years, whether you are dead or alive.
* Assets in a retirement fund, including an RA. Your beneficiaries could receive a pension from the assets in the fund and on this they would pay income tax. If they took a lump sum, lump-sum taxation would apply.
If a beneficiary is not named, the amount will go to your estate, where it will be subject to estate duty.
When the two amendments came into force, the loophole allowed you to “over-contribute” to an RA – namely, to exceed the tax-deduction limit for contributions of 15 percent of taxable income. Although over-contributions are not tax-deductible, the money goes into an investment in which no tax is payable on interest, dividends or capital gains.
This loophole has been closed, with effect from March 1 last year. Estate duty will now be payable on any contributions to any retirement fund that were not tax-deductible, but the provision is applicable only for people who die on or after January 1, 2016.
DEFAULT RETIREMENT FUND OPTIONS
National Treasury has proposed a list of default preservation and investment options that will have to be implemented by all retirement funds.
Anderson says the defaults will apply to the investment strategy while you are an active member, to where to preserve your savings when you change jobs, and to your pension when you retire.
Most retirement funds already have default investment options and many have implemented, or are considering implementing, more defaults that anticipate the proposed regulations.
Anderson says the aim of the mandatory default options is to improve the appropriateness of the investment strategies put in place for you, reduce investment risk and improve the cost-effectiveness of the strategies. The defaults also encourage you to preserve your retirement savings until you elect to retire from your fund, which may well be after you officially retire from your job.
When the proposals are implemented, you will have to take an active decision if you do not want your retirement savings to be placed in any of the default investment options.
Treasury, however, wants you to make sound decisions, so in the draft regulations it proposes the appointment by your fund of retirement benefit counsellors who will:
* Need to be qualified;
* Explain the default strategies to you; and
* Be paid by your retirement fund.
Hanekom says the Sanlam Benchmark Survey shows that more than 80 percent of retirement fund members who are given investment choices choose the default option. He expects that members will continue to select the defaults – especially if they are seen to be efficient and cost-effective.
The proposed defaults are:
In-fund preservation
This default is for members who lose or resign from their jobs and become entitled to a withdrawal benefit from their fund.
Currently, the “default” applied by most retirement funds is to pay you your accumulated benefits as cash. You have to take an active decision to preserve your benefit, either by leaving it in your fund (if the rules allow it) or by transferring it to a new employer’s fund, commercial preservation fund or RA. If you leave the money in the fund, it must remain there until your normal retirement date, set in terms of the fund.
Under the proposed regulations, the default option will be to leave the money in your current fund. You will become a paid-up member of the fund. Your benefits will continue to grow tax-free in the fund. However, you will not be able to make any new contributions, as is currently the case with commercial preservation funds. You will also lose any group life assurance benefits.
Anderson says that if you leave an employer that provides group life and disability cover as part of your retirement savings package, you need to make sure you have sufficient cover of your own or in your new fund. He says that some group policies do, however, allow you to convert your group cover into an individual policy underwritten by the current assurer, with no additional medical checks when you leave your employer. You should check with your fund whether this option is available.
Hanekom says that, currently, few stand-alone retirement funds, and even fewer umbrella retirement funds, offer members the option to become deferred or paid-up members after leaving an employer.
So although you already have the right to be a deferred member, many retirement funds do not offer the choice, requiring you to transfer your savings, typically with additional costs, to a different fund.
The intention of Treasury is that all employer-sponsored stand-alone retirement funds, union funds and umbrella funds will be required to make in-fund preservation the default for members.
Hanekom says there is nothing to stop a stand-alone or umbrella fund from introducing an in-fund preservation option immediately. A legislation change is required to allow umbrella funds to do so, but many commercial umbrella funds offer preservation products from their associated administration/asset management companies.
He says the default in-fund preservation option, combined with other changes, will give you far more flexibility, as well as reducing the cost of preserving your savings. The two main advantages are:
* Improved options if you become a paid-up member of a fund before your normal retirement date. Previously, if the fund rules allowed you to become a paid-up or deferred member, your savings could be left in the fund, but they could not be withdrawn before the normal retirement date set in the rules of the fund. This limitation has been lifted and you can now withdraw from the fund at any time after becoming a paid-up member, if the rules allow.
Hanekom says you will have the freedom to leave the money in the fund, knowing that you can review your decision later, particularly if you cannot find a new job and need to withdraw the money as cash. Any withdrawal will be subject to taxation.
* If you preserve your money in the fund, you can retire and buy a pension at your normal retirement age or any date thereafter. And, at any stage after your normal retirement age, you can elect to receive a pension from the fund (see “Default pension”, below).
Hanekom says if you leave your current employer before retirement date, you will have to decide:
1. Whether or not to accept the default of leaving your money in your employer’s retirement fund, which will entail no tax consequences or additional costs. If you do not want to do this, you will have to inform your fund to do one of the following:
– Pay the benefit to you in cash. There could be significant tax consequences. It will also mean that, if you spend the money, you will probably not have sufficient savings for a financially secure retirement.
– Transfer the money to a commercial preservation fund. This will entail costs, such as advice and product fees. There will be no tax consequences unless you transfer from a pension fund to a provident-type preservation fund.
– Transfer the money to an RA. This will entail costs, and there will be tax consequences if you are a member of a provident fund, but not if you are a member of a pension fund.
– Transfer to the fund of a new employer. This may or may not entail additional costs and after March 1 will not have tax consequences.
2. How to save and how much to save for your retirement if you do not become a member of a new employer-sponsored fund. You cannot make additional contributions to your current fund if you elect to become a paid-up member or a phased retiree (if you retire and delay taking your benefit). If you earn an income from another source, you will need to contribute to an RA if you want to benefit from the tax breaks on retirement fund contributions.
3. On changes to your life cover. If you leave a fund or remain as a paid-up member or phased retiree, you will no longer belong to the group life scheme. You will need to reassess your individual cover.
4. Whether you want to “stagger” your retirement. Hanekom says that very few people now stay in one job for life; they belong to a number of retirement funds over their careers. One advantage of the proposed changes is that by remaining a paid-up member of a fund you will, in effect, be able to stagger your retirement, by retiring (receiving a pension) at different dates from the different funds. So at retirement, if you took a lower-paying job, you could make up for an income shortfall by buying a pension with the benefit from one of these funds. You could then turn to the other funds when you decided to stop working. You will, therefore, have to weigh up the cost advantages of consolidating your benefits in the various funds (which could be significant) against the staggered retirement options they may offer.
Hanekom says that if you leave your savings in a retirement fund:
* You will have to decide on the date you want to be paid a pension. You will then have to decide:
– How much to take as cash and how much as a pension, with a maximum allowed as cash being one-third of your savings in a pension fund and contributions to a provident fund made after March 1; and
– Whether to use the default pension provided by the fund or buy a pension from a retail living annuity provider or life assurer.
* You will have to make estate-planning decisions. Hanekom says that if you leave your money in the fund, it will be treated as a death benefit. In other words, you do not have the final decision on how the benefits are distributed. In terms of the Pension Funds Act, the fund trustees will decide how to allocate your savings, taking account of who you have nominated as beneficiaries and your actual dependants and their financial needs. This may affect decisions about how you structure other, discretionary, assets in your estate.
Hanekom says that you should always complete your fund’s beneficiary nomination form so that the trustees know who to consider as dependants and nominees. The more detail you provide by way of notes about who is financially dependent on you, the better. The trustees may not honour your nominations if it means someone who was dependent on you will be left without sufficient financial support.
Default pension
Treasury’s draft regulations propose that the rules of all defined-contribution retirement funds and RA funds will have to provide for a default annuity (pension). This means that, when you retire, unless you choose otherwise, your pension will be provided by your retirement fund or a pension provider chosen by your fund.
Anderson says the proposal is not for a single, one-size-fits-all default. Most funds are likely to provide you with a limited set of well-thought-through options from which you can choose. If you do not choose, you will be “defaulted” into one of them.
He says you will have to have access to a retirement benefits counsellor not less than three months before your retirement to advise you on your options and on the default pension strategy.
No single type of default annuity can be optimal for all members of a retirement fund, Anderson says. “Every member has different needs and wants as well as saving histories, risk tolerances and preferences for income in retirement.
“It is clear that, for most funds with diverse memberships, a range of annuity choices will have to be offered to members, with accompanying advice to ensure that individual members understand the choices and end up with the right pension,” he says.
Anderson says that if your fund offers you a default annuity without advice, it could be held accountable if things go wrong.
The draft pension default regulations provide for a retirement fund or life assurance company to offer a choice of default annuities. You will have to inform your fund if you do not want a default. In this case, you will have to decide whether you want:
* A living annuity, where your income will depend on how you invest your savings and the returns that your investments earn;
* A with-profit annuity, where a pension is guaranteed and the increases are based on the investment returns earned by a life company; or
* A guaranteed annuity provided by a life assurance company.
If you choose a guaranteed annuity, you will have to decide on the product provider and what type of annuity you want – for example, whether your pension will increase every year in line with inflation, and whether a surviving partner will be paid a percentage of your pension after you die.
Your fund should be allowed to use an investment-linked living annuity or guaranteed annuity to provide a default pension, subject to some conditions, according to Treasury’s proposals.
* Living annuity. Treasury proposes that, if your retirement fund offers a living annuity as a default pension, it must be provided by the fund, not a commercial product provider. The intention is to reduce the costs associated with commercial living annuities, as well as having an additional check in place in the form of trustees, who will oversee the management of the arrangement.
Treasury proposes strict limitations for default living annuities. These include:
– The pension drawdown level. Normally, you decide what percentage, between 2.5 and 17.5 percent, of the annual value of your retirement capital you withdraw as a pension. The proposals set default drawdown rates that are linked to your age (see link to table at the end of this article), to ensure that your capital will continue to provide a pension throughout your life and that of your surviving spouse (or partner). If you want a higher or lower drawdown, within the prescribed range, you will have to inform your fund initially and on each anniversary of the annuity.
– The underlying investments. Your retirement fund will have to provide a default investment portfolio. If you want a portfolio that is invested more conservatively or aggressively, you will have to opt out of the default.
However, whether you use a default living annuity or one from a commercial product provider, the investments will have to comply with regulation 28 under the Pension Funds Act, which limits a retirement fund’s exposure to a particular asset class or asset. For example, no more than 75 percent of the investment portfolio may be in equities.
The fund’s trustees will have to monitor your pension and warn you if they believe you may be vulnerable to “substantial falls” in income.
* Guaranteed annuity. Your fund may offer you a default pension provided either by the fund or a life assurance company.
A pension provided by the fund may be offered with or without a guarantee of the income level.
If your fund provides the pension without guarantees:
– You must be informed that your pension could vary in line with the value of the underlying assets, the fund’s expenses, and how long you and the other pensioners live;
– The assets used to generate the pensions must be kept separate from the savings of contributing pre-retirement members; and
– The assets must be invested in terms of the prudential investment requirements, as well as the risk-return profile required to provide an income flow to the pensioners.
Your fund can negotiate with a life assurance company to provide a default guaranteed pension if:
– The pension increases are linked to an independently verifiable formula;
– No commissions are paid from your savings; and
– Your fund’s trustees are satisfied that the life company will not go bankrupt.
Investment options
The rules of all retirement funds will need to provide for default investment portfolios for contributing members, unless exempted from this requirement by the Registrar of Pension Funds.
Anderson says the default investment portfolios would need to be appropriate for members, be communicated in simple terms, offer good value for money, be transparent about all the charges you pay (direct and indirect), and not have contracts that lock you in for a specific period.
Retirement funds will have to provide default investment options if the new regulations are implemented for paid-up members, phased retirees and in-fund living annuitants/pensioners. The default investment portfolios could be very different for each of the three groups, particularly pensioners, because of their different investment risk profiles.
The default investment portfolios for each group could also be different for people of different ages, and with different levels of savings and salaries.
Hanekom says the proposed changes will require you to decide on or take account of:
– Whether to accept a default investment portfolio or another portfolio offered by your fund. These options will differ depending on whether you are a contributing member, paid-up member, phased retiree or in-fund living annuitant.
– If you decide to opt out of the default, you will need to take into account things such as your level of accumulated savings, the optimum investment portfolio you will require to meet your financial goals, and your knowledge of investing, particularly investment risk, so you can understand the consequences of the other portfolios on offer.
FAIR-TREATMENT PRINCIPLES
Your retirement fund needs to show that it takes and implements broad policy decisions and decisions that affect individual members in a manner that treats you fairly.
The Treating Customers Fairly (TCF) framework applies to all regulated financial entities, including retirement funds, and National Treasury sees your fair treatment as one of the objectives of its retirement reforms.
Leanne Jackson, the head of market conduct strategy at the Financial Services Board (FSB), points out that in the case of retirement funds (with their complex responsibility structures involving fund members, trustees, employers and service providers, including asset managers and consultants, administrators and life assurers) all players need to be mindful of TCF. They need to share responsibility and be held accountable for making sure the six desired TCF outcomes are delivered. These are:
Outcome 1. Customers (in this case, fund members) are confident that they are dealing with a firm (fund) where their fair treatment is central to its culture.
Outcome 2. Products and services marketed and sold in the retail market are designed to meet the needs of identified customer groups, and these groups are targeted accordingly.
Outcome 3. Customers are given clear information and are kept appropriately informed before, during and after the time of contracting.
Outcome 4. Where customers receive advice, the advice is suitable and takes account of their circumstances.
Outcome 5. Customers are provided with products that perform as a firm has led them to expect, and the associated service (from the fund, as well as the administrator it appoints) is of an acceptable standard and what they have been led to expect.
Outcome 6. Customers do not face unreasonable post-sale barriers to change a product, switch a provider, submit a claim or lay a complaint.
DEFAULTS: GOOD ADVICE STILL NEEDED
Default retirement options will not mean that you no longer need financial advice, the Financial Planning Institute (FPI) has warned.
The FPI, the professional body for financial planners, has told National Treasury that default options cannot provide “a fair and appropriate solution to each and every member of a retirement fund”, because of the diverse needs, requirements and risk profiles of members.
In a response to the proposed regulations on retirement fund defaults, the FPI says it is vitally important for you to get impartial advice about the default and other options available to you.
The FPI says it agrees with the objectives of the default regulation – the costs should be lower, consumer understanding increased and retirement savings should be preserved. But it says the value added by a financial planner will always far outweigh the costs of making use of the services of that planner.
The FPI says it has reviewed more than 30 research papers that show clear evidence that consumers who receive advice:
* Are wealthier than those who do not receive advice;
* Hold more in financial assets at retirement;
* Act and invest in a more tax-efficient manner; and
* Are more likely to retire comfortably.
Research undertaken in the United Kingdom in 2012 found that:
* The average pension pot available to consumers at retirement for those who sought financial advice was nearly double that of those who did not seek advice.
* On average, the investment portfolios of those
who received advice were £40 000 higher than the portfolios of those who did not receive advice.
* People who receive financial advice tend to contribute more to retirement savings. On average, people who received advice contributed £167 a month for 18.5 years, while those who did not contributed £108 a month for 17.5 years.
Other research, conducted by banking and financial services company HSBC in 17 countries, has shown that people receiving advice save more than three times the amount saved by people who do not receive advice.
The FPI supports the recommendation in the draft regulation for “benefits counsellors” to be appointed and paid for by retirement funds to assist members in making the most appropriate choices. But the institute wants the concept of benefit counsellors to be taken further than simply advising on retirement issues. It says the role of the counsellors should be extended to “provide holistic financial planning”. In other words, the counsellors should provide advice on everything from life risk assurance to discretionary saving.
The FPI says holistic advice should be provided to retirement fund members when they join a fund, withdraw before retirement and at retirement.
* On joining a fund, advice should include:
– The drafting of a financial plan;
– Assisting with choice of investment portfolios; and
– Potential shortfalls in life goals and how they can be covered.
* On leaving a fund before retirement, advice should include:
– Preparing a plan for withdrawal;
– Recommendations on the various preservation options (become a paid-up member, transfer to the new employer fund or transfer to the individual’s own fund); and
– How much to take as a cash benefit and how much to preserve for retirement, taking into account circumstances such as retrenchment, where cash may be required.
* At retirement, advice should include:
– The drafting of a financial plan for retirement;
– Assessing the appropriateness and suitability of a default option against the financial plan; and
– Considering other annuities when the default annuity option is not in the client’s best interest.