By Kobus Hanekom, head of strategy, governance and compliance at Simeka Consultants and Actuaries (pictured)
In contrast to previous years, the 2015 budget speech by Finance Minister Nhlanhla Nene did not reveal any fresh retirement reform initiatives or general retirement industry proposals. While there is much room for improvement of our retirement funds, they are by international standards in fact very tax efficient and well run.
What we heard in Minister Nene’s speech is a confirmation of Government’s commitment to research and develop the measures that are already on the reform agenda. Government committed to “continue to build on its retirement reform initiative, which aims to facilitate an environment in which all employees can retire comfortably and not face poverty in their old age”. The reforms will:
· Encourage preservation before retirement and annuitisation at retirement
· Improve governance and disclosure of retirement funds
· Reduce costs, which includes greater use of passive funds
· Harmonise regulation and supervision between private and public retirement funds
· Design a uniform tax and contribution system.
The Minister indicated that not much progress has been made with the T-Day and P-Day deadlines. Retirement reforms are expected to be largely in step with progress on social security reform, but this is expected to take longer than anticipated. The social security reform process will only be initiated after Cabinet has approved a framework for consultation with key stakeholders. Against this background we consider it increasingly unlikely that T-Day will be implemented on 1 March 2016 and it may have to be pushed out to 1 March 2017.
Olano Makhubela, chief director for finance, investments and savings at National Treasury, indicated during a keynote address at a pension lawyers conference in Gauteng this week that issues for discussion include municipal funds not covered in the current proposals, and the possible increase in the “de minimus” amount of R150 000 below which the entire benefit can be taken in a cash lump sum. Makhubela also indicated that the scrapping of the means test of the old age pension is not considered a precondition for the implementation of T-Day. Funding constraints currently compel Government to push this initiative out to a later date.
To finalise the legislative framework for retirement reform, engagement will take place directly between key stakeholders such as trade unions, trustees, employers and industry, and within Nedlac. We agree with the Minister that these reforms are urgent and that delays will be to the detriment of members and pensioners. There appears to be a willingness on the part of National Treasury to consider introducing T-day in more than one instalment, to allow members to make increased contributions (up to the proposed 27.5% level) sooner rather than later.
Another matter that is taking longer than expected is the development of regulations on default preservation, investment strategy and annuities. These regulations are now projected by Treasury to be released by July 2015.
A mandatory pension system (part of social security reforms) to help vulnerable workers save for retirement is under consideration. Government will discuss these initiatives with key stakeholders to ensure that a cost-effective and suitable retirement system is designed for this group of workers – or, at a minimum, that a cost-effective default fund is established.
Phased retirement will become effective from 1 March 2015. In terms of this new measure, retirement fund members may defer drawing their retirement income from their fund until after their retirement from their employer. Our interpretation of the current legislation is that a fund has no option but to retain the benefits of a member who elects to go on phased retirement. Treasury has been requested to provide greater clarity on this issue. We welcome this measure, as it will provide more flexibility for retirement fund members and encourage the preservation of retirement assets. To limit tax planning opportunities however, it is proposed that a maximum age at which withdrawals must be taken, be introduced. Although no age was mentioned, 75 may be appropriate in this regard.
Increase in the maximum marginal tax
One of the most significant announcements in this year’s budget is the increase in the maximum marginal tax rate from 40% to 41%. This will raise tax by R21 a month for a taxpayer below the age of 65 with an annual income of R200 000, by R271 a month for those earning R500 000 per year, and R1 105 a month for those earning R1.5 million per year.
After the tax brackets, rebates and medical scheme contribution credits have been adjusted for inflation, the net effect will be that there will be tax relief for those earning below R450 000 a year and increased taxes for those with higher incomes.
While the increase in the maximum marginal tax rate will affect a significant proportion of taxpayers, it does serve to highlight the tax efficiency of retirement funds. Retirement funds are virtual tax havens – you will not find a more tax- and cost-effective way to provide for retirement in South Africa. We are also very positive about the tax-free investments to be introduced from 1 March 2015. If implemented correctly they have the potential to improve the savings rate of South Africans. We recently compared the tax efficiency of retirement funds, tax-free investments (TFI) and collective investments (CIS):
Consider a 40-year-old individual who earns a salary of R10 000 per month and in respect of whom an employer makes a monthly contribution of R1 000 to a provident fund over a term of 20 years. Compare this to a similar investment in a TFI or CIS. Assuming the contributions are placed in a balanced fund earning a return of 5% above inflation, our projections show that the provident fund investment will be 10% better than the TFI, which in turn will be 16% better than the CIS. In this exercise we assumed the same cost structure. The difference is likely to be even larger once the actual costs of each investment type are factored in.
If the individual earns R100 000 per month (taxed at the highest marginal rate), the provident fund investment will be 35% better than the TFI, which will in turn be 14% better than the CIS.
Using the proposed new tax tables, the retirement fund investment will be almost 2% – even better than the TFI investment (1.7%). The TFI in turn will be almost 2% (1.8%) better off than the CIS. Based on these assumptions a retirement fund investment – for a person in the top new marginal tax bracket – will produce a net after-tax return that is 37% better than a TFI and 56% better than a CIS. For a person earning R10 000 per month the retirement fund would be 10% better than a TFI and 27% better than a CIS.