Do not rush into a division of retirement savings in a divorce settlement. Judging from recent court cases, you may find that, unless you are very careful, you will not receive what you expected.
The warning comes from Alexander Forbes, the largest administrator of retirement funds in South Africa, pension fund lawyer Karin MacKenzie and Advocate Alec Freund SC, who specialises in pension law. MacKenzie, a director at Herold Gie Attorneys and a former senior member of staff at the office of the Pension Funds Adjudicator, is doing a master’s on the division of retirement savings on divorce.
Freund made his warning when updating a recent meeting of the Western Cape branch of the Pension Lawyers Association on new court judgments on pension issues.
John Anderson, the head of national consulting strategy at Alexander Forbes, says that 28 percent of the divorce settlements served on funds administered by Alexander Forbes are rejected.
After the clean-break principle was introduced into the Pension Funds Act, there was an increase in the number of divorce orders that fell into the “unsure” category – those that require further clarification – but the number of those orders has decreased over time, Anderson says.
The clean-break principle allows a non-member former spouse to access on divorce an agreed share of the member spouse's retirement savings.
But, Anderson says, the proportion of divorce orders that are unenforceable has increased, from eight percent to 24 percent (see “Why a fund may reject a divorce settlement”, below).
He attributes the increase to “the fact that the divorce orders we are seeing are increasingly being done in a more complex manner.
“Although it appears that a lot more thought goes into the settlements, and that the parties are obtaining legal assistance, the complexity introduced is in many instances not practical and has resulted in more unenforceable divorce orders.
“It is clear that legal professionals assisting people with divorce orders should improve the advice provided and take practical implementation into consideration. The area is becoming increasingly specialised, and hence lawyers with the right experience should be assisting here.”
Anderson also says that once a non-member former spouse has been awarded a share of the member former spouse’s retirement savings, he or she should take great care in deciding what to do with the money (see “Savings not being preserved”, below).
MacKenzie says it is important that you understand what is meant by “pension interest” in a divorce settlement that involves assigning retirement savings, whether the savings are in an occupational retirement fund (either a pension fund or a provident fund sponsored by an employer, a trade union or an industry association), a retirement annuity (RA) fund or a preservation fund sponsored by a financial services company (see “What is a pension interest?”, below). A pension interest applies only to these funds and not to an annuity (a pension) bought at retirement, nor, as was decided in a recent court case, to a former fund member’s retirement savings that are held in the fund until the former member retires (see “Clean-break doesn’t apply to deferred pensions”, below).
MacKenzie says that, before obtaining a divorce, both the member spouse and the non-member spouse should ask the retirement fund or its administrator about the current fund value and the present value of the pension interest – these two values may differ – to ensure an equitable division of the assets.
“If, as is frequently the case, the member spouse is reluctant to co-operate in this process, the non-member spouse is entitled to ask the fund for the relevant information. If the fund is not prepared to divulge the information, the non-member spouse would probably be entitled to it in terms of the Promotion of Access to Information Act,” she says.
The current fund value is the amount typically reflected on a benefit statement and indicates the value of the member’s investment – the rand value of all the assets in the member’s underlying portfolios on a given date in a defined contribution fund or an RA fund, or the actuarial reserve value (the amount notionally held by the fund to provide for the future retirement benefit) in a defined benefit fund.
In most defined contribution funds, the resignation benefit will equal the current fund value, but this may not be the case in defined benefit funds.
In RA funds, because the pension interest consists of contributions plus simple interest, the effect of compounded returns usually means that the current fund value will be significantly higher than the pension interest.
MacKenzie warns it is important that you use the correct name of the fund at all times.
“If sufficient uncertainty exists as to which fund is in fact intended, the [divorce] order will not be enforceable. Orders are frequently obtained in which the insurance company that sponsors or administers the pension fund is mistakenly cited instead of the fund. It is not sufficient to refer to the sponsor or administrator (for example, the Sanlam pension fund), as these financial institutions typically operate several funds,” she says.
It is possible to obtain an order that directs the fund to endorse its records to reflect the interest of the non-member spouse. This may be advisable if it is anticipated that there will be delays in payment or that the member might leave the fund prior to payment, MacKenzie says. However, this will not be necessary in most cases, because the submission of the divorce order to the fund will activate the payment process, she says.
MacKenzie says the law provides for two separate systems for a non-member spouse to access a member spouse’s pension on divorce. These are:
Freund says the amended Act empowers a court granting a decree of divorce to order that any part of the pension interest is assigned to the non-member spouse, and provides for the fund concerned to make the relevant payment directly to him or her.
However, in terms of the 1989 amendment, the fund was to pay the non-member spouse only once the pension benefit accrued to the member spouse. An example of an accrual event would be when the member withdrew from the fund or retired.
Freund says although the amendment improved the legal position of the non-member spouse, it was criticised on several grounds. One of the criticisms was that the benefit assigned to the non-member spouse was frozen at the date of divorce, so that he or she did not benefit from any interest or capital growth on his or her portion. Related to this was the delay in being able to access the allocated portion.
Freund says there was considerable support for the introduction of the clean-break principle, which allows for a pension interest to be divided on divorce and not only later, when it accrues to the member.
As a result, there were further amendments to the Divorce Act in 2007 and 2008, and the clean-break principle was introduced into the Pension Funds Act in 2007.
In terms of the clean-break principle, Freund says, the assigned portion of the pension benefit is deemed to accrue, subject to certain provisos, on the date of the divorce order. At that time, the non-member spouse can choose to be paid the assigned amount directly or to have it transferred to an approved pension fund.
MacKenzie says the statutory option (that is, the provisions of the Divorce Act) applies only to unaccrued benefits.
An unaccrued benefit is one where the member spouse is still an active member of a fund and has not yet retired or withdrawn from it. In this case, the investment in the fund is not an immediately quantifiable asset but a future claim against the fund, the content and amount of which can be determined only at a later date, when the member retires or withdraws from the fund.
Parliament created a statutory formula for determining the value of the right (referred to as the pension interest) and deemed it to be an asset in the estate capable of division at divorce.
A court, in issuing a decree of divorce, is empowered to allocate a portion of the pension interest to the non-member spouse. In this statutory dispensation, a pension fund presented with such a divorce order must deduct from the member’s pension interest the amount allocated to the non-member spouse and pay it directly to him or her.
MacKenzie says it is crucial to bear in mind the common law and the statutory systems and to determine whether or not the benefit has accrued.
“If it has, it may be dealt with only in terms of the general matrimonial law provisions. There are many instances that have come before the courts where parties have erroneously applied the statutory provisions to pension benefits that have already accrued, and such orders are unenforceable against pension funds. It is therefore vital, when framing divorce orders, to establish whether or not the member spouse has become entitled to a benefit, or will become entitled to one on or prior to the date of divorce. If so, the statutory model can have no application, and the claim is a personal one between the spouses, regulated by common law principles and the division of matrimonial assets.”
MacKenzie says the matrimonial principles take account of pension entitlements that have already accrued to a spouse as assets in that spouse's estate, or in the joint estate if the couple is married in community of property. This would include a lump sum payment and the right to a monthly pension.
“In these cases, the non-member spouse is entitled to have the value of the pension assets included in a calculation aimed at dividing the joint estate, or the value of an accrual claim.
“This is straightforward in the case of a lump sum. Where an accrued benefit is payable as a monthly pension, the non-member spouse is also entitled to share in this, although only at the time that each monthly instalment is payable,” MacKenzie says.
The member and the non-member spouse may agree on the division of the accrued pension assets or, in the absence of an agreement, a court may direct an allocation to the non-member spouse, she says.
Spouses have two choices on how to allocate a pension benefit if it has not accrued at divorce, MacKenzie says. The choices are:
There are a number of issues that must be considered when formulating a divorce order that includes the division of retirement savings, MacKenzie says. These are:
The parties can also agree to allocate a rand amount, provided that it does not exceed the pension interest. Here it would be prudent to state “Rxx of the pension interest”, once again for purposes of clarity.
Interest is regulated by section 37D(4) of the Divorce Act, which provides for investment growth on the allocated portion. However, this takes effect only if the assigned pension interest is not paid over within the statutory prescribed time, which can be several months after the date of the divorce.
She warns that such clauses in a divorce agreement must be drafted carefully and be separate from, and in addition to, the statutory entitlements. A failure to do this may make the order unenforceable against the fund to the extent that the intention is not clear.
Claims that fall outside the scope of the statutory provisions are in effect only between the divorcing spouses. The retirement fund cannot be co-opted into making additional payments or into transferring the tax liability.
WHY A FUND MAY REJECT A DIVORCE SETTLEMENT
Divorce settlements that award a share of a fund member's retirement savings to a non-member spouse are rejected by retirement fund administrators for various reasons, including the court order not stating the name of the fund.
Nancy Andrews, a senior legal adviser at Alexander Forbes, says an administrator should not have a problem with meeting the terms of a divorce settlement if the retirement fund is identifiable. But where a member belongs to a number of retirement funds (for example, a pension fund and a provident fund), it will not be clear against which fund to enforce the divorce order if the order states only “the fund”. It is fine if the order specifies “the funds”: the administrator would apply the order against all the funds to which the spouse belongs. But if it specifies a singular “fund”, it can create a problem, Andrews says.
Andrews says that other problem areas are:
The definition of a pension interest in the Divorce Act has a connotation that, in order to calculate the pension interest, the member has to be in active employment and active fund membership at the date of divorce so that it may be deemed that he or she has resigned on the date of divorce and his or her former spouse is now entitled to a portion of his or her fund benefit as at that date.
However, if your employment (a condition for fund membership) has already terminated at the date of divorce, you cannot be deemed to have resigned at the date of divorce and your former spouse cannot be paid a portion of what would have been your fund benefit at the date of divorce (see “Clean-break doesn’t apply to deferred pensions”, below).
“We have seen in some divorce orders that the non-member spouse, as part of the divorce settlement, is compelled to preserve the benefit and is being forced to transfer the benefit to a preservation fund,” Andrews says.
In terms of the Pension Funds Act, a fund is compelled to give the non-member spouse the right to decide how the pension interest award should be paid. On presentation of a valid divorce order, the fund has 45 days to request the non-member spouse to decide how the pension interest due must be paid. The non-member spouse has 120 days in which to make a decision.
If the decision is made in terms of the divorce settlement agreement and the fund is not made a party to the agreement, the fund cannot enforce that provision.
Andrews suggests that if a non-member spouse's decision on how his or her share will be paid out by the fund is agreed to upfront in the divorce settlement agreement, the fund must be made party to this and cited as a party on the summons. Where the fund is not made a party to the divorce order, the fund would be compelled to follow the provisions of section 37D and request the member to make a decision.
There have been some divorce orders where the value of the pension interest is a fixed amount and not a percentage of the fund credit. These fixed amounts include the value of the benefit in the section 14 transfer, on which approval is still pending, she says.
Where the value agreed between the parties includes the transfer value from the transferor fund and the contributions made to the transferee fund in the period between the divorce and the approval of the section 14 transfer, it is important for the attorneys of the divorcing parties to ensure that the fund against which the divorce order is made is the correct one.
Alexander Forbes’s view is that where the amount assigned to the non-member spouse includes the transfer values in terms of a pending section 14 transfer, the order should be made against the transferor fund as opposed to the transferee fund, Andrews says. This would imply that the non-member spouse would be entitled to receive an award of pension interest from both funds if the section 14 transfer is not finalised by the date of divorce.
“We saw the impact of this on members during the financial crisis,” she says.
“There are then difficulties in executing the new divorce order, since monies were previously paid to the non-member spouse and the amount previously paid out is not taken into account in the new divorce settlement agreement. Poor wording and not ensuring that the new divorce order is practically implementable can then lead to problems for either the non-member spouse or the member. In some cases, the non-member spouse needs to pay back money to the fund; in others, a further payment would be needed from the fund to the non-member spouse.”
Andrews says it is important that those who advise the parties to a divorce have a thorough understanding of how such calculations are done and ensure that the new divorce order can be implemented without unintended consequences.
Andrews says the implementation of divorce orders is delayed for various reasons – they are given an “unsure” status by administrators. The reasons include:
SAVINGS NOT BEING PRESERVED
Only 2.87 percent of non-member spouses who receive a share of a former spouse’s retirement savings are preserving the money in tax-incentivised retirement-savings vehicles; the rest are taking the cash. This is according to John Anderson, the head of national consulting strategy at Alexander Forbes.
To make matters worse, he says, there is growing evidence that couples are divorcing solely to get their hands on retirement savings.
Pension lawyer Karin MacKenzie says the government may have to consider placing limitations on the amount of pension interest that may be awarded to a non-member spouse in order to stop “artificial attacks” on retirement savings.
Anderson says there has been a slight improvement since last year in the proportion of non-member spouses who preserve their share of the retirement benefits: 2.87 percent as opposed to 2.37 percent.
Non-member former spouses must carefully consider what they will do with their share of a pension interest, he says. They can take their share as cash, which will be taxed, or transfer the amount, without tax consequences, to another fund such as a preservation fund or a retirement annuity fund.
Transferring the funds to another fund will better ensure that the non-member spouse has a financially secure retirement, he says.
Anderson says although the absolute number of divorce orders submitted to retirement fund administrators is still very low, there has been an increase in the number of divorce orders submitted to Alexander Forbes.
The rate has been increasing by 43 percent on average over the past three years.
He says the increase can be attributed to changes in the legislation affecting retirement benefits on divorce and increasing awareness by non-member spouses of their rights to a share of the benefits.
The upward trend can be expected to continue given the high divorce rate in South Africa.
“We have estimated that funds receive divorce orders in one out of 10 divorces at present. We have also seen more cases where divorce orders are being used to access retirement benefits – that is, people getting divorced purely to get access to retirement funds,” Anderson says.
CLEAN-BREAK DOESN’T APPLY TO DEFERRED PENSIONS
The legal definition of a pension interest is critical in deciding when a non-member spouse becomes entitled to a share of a fund member’s retirement savings, Advocate Alec Freund says.
Citing a recent judgment of the Supreme Court of Appeal (SCA), Freund says that the date on which a member resigns from a fund and the date of the divorce directly affect when the non-member spouse may expect to receive his or her pension interest.
The SCA determined that Elizabeth Krugel, the ex-wife of a former member of the Eskom Pension Fund, was not entitled immediately to receive a share of her former husband's retirement savings in the fund. This was despite a divorce settlement that awarded her a share of the savings and a determination by the Pension Funds Adjudicator that the fund must pay up.
However, the Eskom Pension Fund, concerned that, if the member went to court, it may have to pay out twice, and presumably wanting legal clarity on this important principle, took the matter all the way to the SCA.
Long before the divorce, Mr Krugel had resigned from his employment and had elected to defer his pension benefit in the fund. He had become a deferred pensioner in terms of a rule of the fund.
The divorce settlement, which had been made an order of court, recorded that Mr Krugel had a pension interest in the Eskom fund and provided that Mrs Krugel was entitled to 25 percent of that pension interest, payable to her as soon as Mr Krugel became entitled to the pension interest.
The agreement further provided that the spouse’s attorneys would secure the registration of an endorsement against the records of the fund - as provided for in the Pension Funds Act. But the fund refused to register the endorsement against its records on the basis that, at the time of the divorce, Mr Krugel, as a deferred member, no longer had a pension interest in the fund as contemplated in the Pension Funds Act.
Freund says the SCA held that the legislation contemplates an award to the non-member spouse of part of the pension interest, calculated at the date of the divorce but with effect from a future date when the benefit accrues to the member spouse. “It held that, where the benefit has already accrued, the provisions of the Act do not apply and that Mr Krugel could not again be deemed to become entitled to a resignation benefit.”
The court ruled that Mrs Krugel could claim her share when Mr Krugel turned 55 and the benefit became due to him. Freund says it was open to the parties to agree, as they did, that Mrs Krugel would be granted a share of the pension benefit when it was paid out.
“They could have agreed, instead, that the wife should be paid by the husband at some earlier date some amount to reflect the value of the husband’s entitlement to the pension payout.
“What the parties cannot do by agreement is to invoke the statutory mechanisms under the Pension Funds Act in a situation to which that Act does not apply. This means, for example, that a non-member spouse cannot impose obligations on a pension fund (rather than on the member spouse) in terms of the Pension Funds Act in a situation in which the Act does not apply.”
In a similar case, the Durban High Court ruled in favour of the Protektor Preservation Fund, which had sought a declaratory order allowing for the payment of a pension interest from the fund.
Freund says the case arose from before the 2008 amendment to the Pension Funds Act that made allowance for a pension interest in a preservation fund. At the time of the divorce, the definitions of a pension interest pertained only to pension funds and a retirement annuity funds – not to preservation funds.
The court agreed that the definition of a pension interest “be read to include the after-tax withdrawal benefit (as defined in the applicant’s rules) that would be payable to a member if he or she had opted to take a total withdrawal benefit as at the date of divorce”.
Freund says the court’s ruling was not very different from the subsequent amendment to the Divorce Act.
However, he also says: “The correctness of this decision is open to doubt and its precedential value is not strong. As already referred to, this was an unopposed application where the issues were not fully argued. What is more, the preservation fund was the applicant wishing to assist its member (and his former spouse) in an application not opposed by either of them. What was sought was an equitable arrangement, which the court sanctioned. Had a non-member spouse brought an application for such relief, opposed by the preservation fund concerned, the outcome might have been different.
“It is difficult to square the outcome of this case with the SCA’s judgment in the Krugel matter. In that case, the court applied the strict wording of the statutory provisions and held that the statutory scheme has no application beyond the situation countenanced by the lawgiver. That seems to me to imply that the Protector Preservation Fund case, which is decided on the basis of an analogy and equitable principles, may not survive scrutiny.”
WHAT IS A PENSION INTEREST?
The deemed (unaccrued) asset in retirement savings that may be divided between a member and a non-member spouse in a divorce settlement is based on a pension interest.
Pension lawyer Karin MacKenzie says Parliament has devised formulae, laid down in the Divorce Act, to calculate the pension interest in an occupational fund, a retirement annuity (RA) fund and a preservation fund. Accordingly, these are the only funds to which the statutory model applies, although in practice these funds are the most common.
The formulae determine the amount of the total interest in the fund that can be divided and assigned at divorce.
The pension interest may be less than the fund value, or the member’s share that typically appears on a member’s benefit statement, MacKenzie warns.
A recent determination by Dr Elmarie de la Rey, the Acting Pension Funds Adjudicator, highlighted that some fund members incorrectly believe that the life assurance that will be paid out should they die or become disabled before retirement is part of their accrued retirement savings or pension interest.
You need to take the following into account:
Where the investment is of long duration, the pension interest will usually be substantially less than the actual fund value standing to the credit of the member. This is because over a longer period compounded returns will usually exceed simple interest, MacKenzie says.
GOVERNMENT PENSION FUND MUST COME INTO LINE
A Western Cape High Court judge has directed the government to submit amending legislation to Parliament to bring the country's biggest retirement fund, the Government Employees Pension Fund (GEPF), into line with the clean-break principle that applies to private sector occupational retirement funds and retirement annuity funds.
The amendment will allow thousands of former spouses of GEPF members to lay claim, in terms of a divorce settlement, to the accumulated retirement savings of GEPF members at the time of divorce.
The reason for the present differentiation is that the clean-break principle was introduced as an amendment to the Pension Funds Act, which is not applicable to government pension funds, most of which are governed by their own independent pieces of legislation.
Currently, non-member former spouses have to wait for an event such as a member’s withdrawal from the fund or retirement before they can claim their portion.
The court was informed that the government was already considering an amendment to the legislation.
In the judgment, Judge Lee Bozalek gave the government 12 months to bring the GEPF into line with the Pension Funds Act on the basis that treating the former spouses of GEPF members differently from the former spouses of people who belonged to funds governed by the Pension Funds Act was unconstitutional.
Arthur Moloto, the chairman of the GEPF’s board of trustees, has told Personal Finance that it is envisaged that the clean-break amendments to the GEPF Act will go through the parliamentary process, after which they will be gazetted well within the 12 months stipulated in the judgment.
The amendment will provide for the “payment of a pension interest to a former spouse of a member on divorce or dissolution of a customary marriage”.
While moving on the clean-break principle, the government has given no indication that the GEPF will be given a major overhaul, making it subject to the Pension Funds Act. Among other things, this would give members the right to complain to the Pension Funds Adjudicator.
At a recent meeting of the Western Cape branch of the Pension Lawyers’ Association, Advocate Alec Freund said that in the High Court case, Matilda Louisa Wiese, the former spouse of a GEPF member, challenged the constitutionality of the legislation governing the GEPF on the basis that the different treatment of non-member former spouses of GEPF members compared with that of non-member former spouses of people who belong to funds governed by the Pension Funds Act violated the right to equal protection and benefit of the law in terms of the Constitution.
The main issue before the court was the appropriate relief to which Wiese was entitled, because the GEPF and the Minister of Finance (under whose control the GEPF falls) effectively conceded the unconstitutionality of the legislation.
However, Freund says, “it occurs to me that, in focusing only on the different provisions regarding accessing pensions on divorce, the parties were perhaps considering the wrong question.
“The right question might have been whether there is a legitimate government purpose in separately regulating pension funds to which the state contributes financially. The difference in issue in the present case is presumably one of many differences between funds to which the state contributes and other funds.”
Although the different treatment was found to be unconstitutional, the judge did not grant the relief sought by Wiese. She sought an order to read provisions into the GEPF Act to bring it into line with the provisions that govern funds regulated by the Pension Funds Act.
Freund says the court accepted that it had the power to grant such an order, but it did not think that this was appropriate in this case, mainly because of the far-reaching nature of the proposed reading in and because of indications that a process of legislative review and reform appeared to be imminent.
If the government fails to meet the 12-month deadline, a complex reading in provision will take effect, conferring similar rights on members of the GEPF to those enjoyed by members of other funds, Freund says.
MARITAL REGIME CAN BE DECISIVE
The way you are married – in or out of community of property - can make a difference to how a pension interest is divided on divorce.
In a recent judgment, the Gauteng High Court had to decide between two claims of a couple married in community of property:
Advocate Alec Freund says the judge was generally sympathetic towards the wife and accepted that the husband had been physically abusive towards his wife, but the judge nonetheless dismissed her claim for the forfeiture of the benefits.
The judge stated that it was clear from the wording of the Divorce Act that the court has a discretion in considering an order for a joint estate to be divided equally, Freund says.
After considering what was “fair and just in the circumstances of the case”, the judge concluded that no order should be made in favour of the husband. Freund says the case is authoritative for the proposition that, in a community of property estate, the court has a discretion, to be exercised in accordance with considerations of fairness, in determining whether or not to make an order allocating some or all of a spouse’s pension interest.
Freund says, “it is not self-evident to me that this is correct, though it may be. I would have thought that the pension interest simply forms part of the community estate, which falls to be divided equally unless a forfeiture order is made. But the language of the provision could be construed, as the judge did, as conferring a discretion on the court.”
It will be interesting to see whether this issue is taken up in future case law, Freund says.
AND DON’T FORGET THE TAX
Beware of the tax consequences of a divorce settlement that affects the apportionment of retirement savings, Advocate Alec Freund and pension lawyer Karin MacKenzie warn.
The taxation of an allocated pension interest is an exceptionally complex field, MacKenzie says, and both the member and the non-member spouse should seek professional advice in this regard.
The taxation of retirement benefits, both before and at retirement, has changed several times in the past few years and may change again in the future, she says.
At present, any allocation of a pension interest deducted by the fund is taxed in the hands of the non-member spouse.
Freund illustrated the nature of the tax consequences by referring to a recent judgment in the South Gauteng High Court in which a non-member spouse lost R135 000 of her share of a pension interest of R300 000, because the divorce settlement did not clearly address the tax issue.
In terms of the divorce settlement, the non-member spouse was entitled to 30 percent of her ex-husband’s pension interest.
The retirement fund paid over her share of about R300 000 and deducted a further R135 000 from her former husband's pensionable interest. The tax deduction was in terms of a provision in the Income Tax Act that, when a non-member spouse’s portion accrued, the member spouse was liable to pay the income tax.
Freund says the same legislation confers on the fund member a right to recover the tax from the non-member spouse.
In this case, the fund member instituted legal action against his former wife to recover the income tax that he had paid, effectively on her behalf. She disputed liability, contending that, on a proper interpretation of the consent agreement made an order of the court, this was not permissible.
“Her defence failed and the former husband's claim succeeded,” Freund says.
Judge Ratha Mokgoatlheng held that her former husband's right to recover the tax paid was not based on contract but arose in terms of legislation.
The court was also not persuaded that the husband had waived his statutory right to recover the tax in the divorce settlement.