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RETIREMENT REFORM: What are the real issues to be considered by employers ahead of the implementation date?

Engaged and happy employees are less likely to look for greener pastures elsewhere. But how do you, as an employer, ensure that your employees are happy and engaged? Is it enough to only pay market related salaries or to provide the bare minimum benefits, like a retirement fund or benefits in the event of death or disability? Or should employers perhaps consider that each of their employees are unique and would therefore also require unique benefits.

Much has been said about the retirement reform over the last two years, and again in the recent days. But how can you as an employer ensure that the changes have a positive impact on your employees. In this article we revisit the changes that are due to be implemented on 1 March 2016, but more importantly consider some of the remuneration items impacted by these changes and for consideration from a human resource perspective.

Background

The 2015 Taxation Laws Amendment Act that was promulgated on 8 January 2016, and the events and debate unfolding thereafter, have been very interesting from an advisory perspective. Statements from specifically Cosatu has sparked a lot of public debate. They certainly have some valid points and their views cannot be simply dismissed as them taking a political position.

A number of the changes we, as employers and employees are facing, were promulgated in the 2013 Taxation Laws Amendment Act already and then amended in the 2014 Taxation Laws Amendment Act to only become effective on 1 March 2016. The new tax rules that will come into effect are designed to harmonise the tax treatment and annuitisation requirements for all types of retirement funds, namely pension, provident and retirement annuity (RA) funds.

Employer contributions to a pension or provident fund will be included in the employee’s remuneration as a taxable benefit. In turn, any contribution to a registered fund, whether by the employer or the employee, will be allowed as a deduction from income. The deduction will be limited to the lesser of R350 000 or 27.5% of the higher of remuneration or taxable income (excluding retirement lump sum benefits, retirement lump sum withdrawal benefits and severance benefits).

In addition to this tax change, employees in provident funds who are younger than age 55 at 1 March 2016, will no longer be allowed to take their full fund benefit as a lump sum at retirement. Similar to the current rules for pension and RA funds, a provident fund member will only be allowed to take 1/3rd of their benefit accumulated after 1 March 2016 in cash. If the member’s benefit is less than R247,500 at retirement, the full benefit can still be taken as a cash lump sum.

Although there has been a lot of negative publicity and concern from especially the unions regarding these changes, the average employee stand to benefit from the tax changes once implemented.

Firstly, all employees who are currently making an employee contribution to a provident fund, would be better off as their own contribution will now also rank for a tax deduction, where it was previously only the employer’s contribution that was not a taxable benefit.

Secondly, although employees in pension funds could already contribute 27.5% of their salary packages tax free towards their employer-sponsored funds where the funds were correctly structured, members of provident funds and those being self-employed and contributing to RA’s, would now also be able to enjoy the same tax benefit.

The above items are relatively straightforward and have been discussed endlessly over the last two years, but what are the real issues to be considered by the employer and human resources ahead of the implementation date?

Education

National Treasury was instructed by Parliament to launch an extensive education campaign to educate retirement fund members on how the reforms will impact them. Their latest publications can be viewed here and can be used by human resources to facilitate the communication to their employees.

Not only is communication and education to employees essential, but trustee boards and management committees should also be educated and to ensure the fund is aligned to the employer’s human resource strategies, as it is a sub-component of the remuneration policy. It is important that these individuals understand the different remuneration structures, flexible benefits, King III, and how other peer group employers structure their pay. This will encourage better informed decisions for the benefit of employees.

Flexible contribution rates

It is imperative that an employer’s retirement fund arrangement support their remuneration philosophy, and not the other way around. Often, the employer’s retirement fund was set up many years ago, and the initial fund structure and rules were drawn up based on the remuneration structure at the time. Although the rules of the fund have been updated over the years to allow for legislative and other changes, the contribution rates are usually still at the same level from when the fund was first introduced. At the time, the rate was determined under a defined benefit structure or based on what the employer could afford in a defined contribution environment. Now, many years later, the fund may have converted from a defined benefit to defined contribution structure, and even though the employer has shifted the risk of obtaining an adequate benefit at retirement to the employee, the employee is not afforded the opportunity to select his/her own appropriate contribution rate.

Many employers in South Africa have also moved from a basic salary plus benefit structure to a Total Cost to Company remuneration structure. And although the employee receives a fixed package from the employer, very few employers offer flexibility and allow their employees the opportunity to structure their package according to their own personal financial needs.

Although we have advocated flexibility for many years, the introduction of the tax changes and the now maximum deduction of 27.5% applying to all employer and individual funds, makes it almost impossible to ignore this option anymore. Employers should offer flexible contribution rates in order for their employees to take advantage of this increased deduction within the employer’s fund. Where the employer’s fund is well-run and offers sufficient flexibility in terms of contribution rates and investment options, an employee would almost in all cases be better off by saving within the fund rather than in a personal RA. Not only will they benefit from lower administration fees and commission, but the investment management fees negotiated by institutional investors (like pension and provident funds) are also much lower than on individual policies. This does however emphasize the requirement for funds to offer investment choice, because if an individual feels they can obtain better investment performance by selecting their own investment portfolios, they may want to minimize their contribution to their employer fund, and rather invest in an individual fund. And where their contribution to a RA was previously limited to 15% of their non-retirement funding income, there is now a fair playing field and they can get the same tax advantage by investing in an RA, albeit at a potentially higher cost.

Flexible pensionable base for calculating contributions

The further change to the base on which the tax deduction will be calculated, from ‘approved remuneration’ or ‘retirement-funding employment’ to the higher of ‘remuneration’ and ‘taxable income’, require employers to revisit the determination of their current pensionable or fund salary. Although the employer is not privy to the taxable income of its employees, as it includes personal additions and deductions, the employer has a clear picture of the employee’s total remuneration. However, the majority of employers calculate pensionable salaries as a percentage of remuneration or Cost to Company, and the market average is between 70% and 75%. Although we are not suggesting that this should uniformly be increased to 100%, employers should allow their employees to elect a pensionable salary equal to 100% of remuneration to provide them an opportunity to take full advantage of the tax changes.

High-income earners

The one area where employees would be worse-off due to the tax changes, is where higher income earners’ deductible contributions will be capped at R350,000 per annum, which will include costs and premiums in respect of insured benefits offered by the fund, eg. group life assurance (GLA). Members who currently pay more than R350,000 (by way of their combined personal and their employer’s contribution) will, from 1 March 2016 pay tax on the contributions above the capped amount and will accordingly see a reduction in their take-home pay. The contributions to a fund that was not allowed as a deduction as a result of the limit, may rank for deduction in the following year of assessment, subject again to the limitations.

Employers may consider implementing the limitation in their fund rules, but we believe it is more important for the affected employees to have the opportunity to reduce their contributions to the fund on a voluntary basis. Some individuals may choose to continue to contribute above the tax-free limit, although without the tax benefit, there is a level playing field for other types of investment. It is critical for these employees to receive financial advice and to understand the impact of their choices.

Understanding the costs of running your fund

It is a well-known fact that the different layers of charges involved in running a retirement fund, are not transparent and therefore not well-understood by employers and fund members. Those who claim that they have this best bedded down, are often the most ignorant. National Treasury first published a paper in July 2013 on Charges in South African Retirement Funds. Further draft regulations were also published in July 2015 that aim to lower the charges and improve market conduct in the retirement fund industry. A copy of this publication is available here.

The only way for employers, fund trustees or management committees to understand the true cost of running their fund, is to conduct a detailed investigation into these items. Charges may include administration fees, policy fees, benefit consulting fees, financial advisor fees, risk charges, asset management fees, manager selection fees, guarantee charges, capital charges, performance fees, platform fees, and other charges levied on events such as switching investments, leaving the plan, or terminating a policy. These changes can be levied as a fixed rand per member, a percentage of salary or a percentage of assets under management.

Ultimately these costs are borne by your employees, and it is therefore important that employers do not lose sight of this important aspect amongst all the debate of the current tax changes. It is quite interesting that the various fund managers and financial management companies are generally in strong support of the retirement reforms. These institutions are very happy to be on the receiving side of the reforms, as compulsory annuitisation of savings at retirement means an automatic increase in their business. Where there has been proper member education and implementation of member education, one can argue that retirement reform would not have been necessary, as the mischief of uneducated withdrawals and spending, would be less prevailing.

Next step for employers

Although the tax changes effective 1 March 2016 require very little change from employers and fund trustees, and employers could potentially get away by making a few relatively small changes to fund rules, you would be doing your employees an injustice if you do not use this opportunity to revisit your fund structure and give them the opportunity to make full use of the maximum tax free savings. Especially employees closer to retirement would appreciate the opportunity to save tax-free and in a cost effective manner.

About the Author

Mentje Larney is an actuary and specialist remuneration, benefit-and tax consultant at Remuneration Consultants and operates in a niche consulting capacity to various employers. Mentje also presented to Parliament’s Standing Committee on Finance in November 2015 on the proposed Retirement Reform changes on behalf of the South African Reward Association (SARA).

National Treasury Retirement Reform Documents

Annexure B Impact of Annuitisation  
Annexure C Data on Members and Net Pay  
Annexure D NT Consultation Responses  
Annexure A Q&A  
Additional Considerations  
Advantages of Reforms  
TLAB A-List  
TLAB B-Bill  
Charges in South African Retirement Funds