The retirement system would be vulnerable to “massive leakage” from pension to provident funds. In his words, “who would want to remain in pension funds or retirement annuities if they can get the tax deduction at a provident fund without annuitisation?”
On the face of it, we agree: given the choice, almost everyone would like to have the lump sum option at retirement. However, we very much doubt that removing the lump sum option for provident funds will prevent the “leakage” that our retirement system already permits.
No new tax break for provident fund membersMr Momoniat makes the point that, for the next two years at least, provident fund members will now enjoy the same tax breaks as pension fund member. This means they can claim contributions up to 27,5% of gross remuneration. In return, they must submit to compulsory annuitisation, at least on contributions made after 1 March 2018.
But provident fund members already had this tax benefit. Yes, in the past only the employer could deduct contributions to a provident fund, but this was a question of form rather than substance: the fund rules may have specified an employer contribution but in effect the employee enjoyed a tax-free contribution.
SARS allowed provident fund contributions up to 20% of pensionable salary. Following the tax harmonisation, this has been increased to 27,5%. This may sound like a tax present but in reality few private sector retirement fund members save above 15% of their income, let alone 20% or more. Increasing the permitted deduction to 27,5% is thus an empty gesture. High income earners – who could potentially afford to save at a higher rate – are curtailed by the R350 000 deduction cap.
A small number of provident fund members do contribute in their own name and some may now see an increase in their take home pay. But the majority won’t because they fall below the tax threshold (which is why their contributions are structured as employee contributions).
The bottom line is that in making these tax concessions for provident fund members, National Treasury has conceded very little, and provident fund members have gained very little. It is therefore disingenuous to suggest that mandatory annuitisation is a fair trade for tax-deductible employee contributions.
If the previous tax benefit for pension and provident fund members was materially the same, then there is no basis to claim that pension funds will now be perceived as inferior. Ultimately, the decision to offer a pension or a provident fund lies with the employer; they have always made this decision with full awareness of the different annuity requirements, and employees have always accepted this decision.
The reality is that investors don’t weigh up the tax benefit against the annuitisation requirement. To wit, retirement annuities have previously offered a much lower tax benefit than pension funds, despite being subject to the same annuitisation requirement. These are voluntary savings products for individuals, which have historically been taken out in large numbers. In any event, these members cannot now “arbitrage” retirement annuity and provident funds, as Treasury suggests, as the latter is available as a group scheme only.
So this notion, that we will see a migration out of pension and retirement annuity funds into provident funds is unfounded.
Mr Momoniat’s contention that no one would voluntary choose annuitisation undermines his own cause. It is also not borne out by the facts – many provident fund members voluntarily invest in a living annuity, because this is, in many cases, the most sensible and tax effective way to manage retirement savings.
To offer just one illustration, someone aged 65 taking a R1,5m lump sum at retirement will incur tax of almost R300 000, as well as tax on subsequent investment income. By investing two thirds into an annuity, they can avoid paying tax on both their one-third lump sum benefit and on their subsequent annuity income.
The more relevant and contentious issue in this debate is the annuitisation threshold of R165 500. Annuitising this amount promises a guaranteed inflation-linked income of just R1 000 per month for a 65-year old single male. That is barely $60 a month, or $2 per day. Is that National Treasury’s benchmark, the breadline? Savers should not be subjected to this indignity.
Little to stop pension fund members cashing out as wellThere is an obvious reason why employees don’t mind pension funds: they can easily avoid the annuity requirements. If they resign before reaching normal retirement age, they have the option to take their entire benefit as a lump sum.
And they will have no qualms about doing so because for members with a large balance, the tax impact is small, and for those with a small balance, the tax incentive has invariably been forfeited already, through prior withdrawals.
To contextualise, Treasury offers an incentive to “retire” rather than “withdraw” from a fund: the tax free lump sum on retirement is R500 000, but only R25 000 on withdrawal. The tax saving is R90 000.
That sounds enticing on paper, but in practice it is insignificant once the benefit rises in value. On a R500,000 fund balance, the difference in the pay-out is still material (17%), but on R1m it is down to 10%, on R4m below 4% and on R10m barely 1%.
Fig 1: Tax impact on pay-out: withdrawal lump sum versus retirement lump sum
Given our position on this issue, it may seem self-serving to quote the modest tax impact on larger pay-outs. Only people who earn, save and preserve diligently their entire life are likely to end up with R1,5m or more (in today’s money terms).
Those who do not preserve on changing jobs will end up with much a smaller asset. According to the annual Sanlam BENCHMARK Surveys that is the great majority, some 80% of employees.
And that is the point. People who withdraw every time they change jobs will have forfeited their R500 000 tax free lump sum benefit long before retirement age. For them, there is no tax incentive to “retire” from their pension fund, no further opportunity cost to withdrawing. Undoubtedly, most stay true to form and resign before reaching normal retirement age, in order to cash out.
Invariably, the other 20% are mainly higher income earners who have no need of a periodic cash injection to manage their finances. They will accumulate large savings and not be swayed by the R90 000 tax saving in their retirement planning.
Pointless battle
Treasury’s retirement reforms are well-meaning and for the most part welcome, but the recurring delays and about-turns do not serve savers, or the industry, or Treasury’s reputation. Pursuing this stand-off with the unions will further undermine its credibility. There is simply no point demanding that the stable doors be locked at night if they are allowed to stand open all day.
Digging in on this point is only justified if the retirement system imposes compulsory preservation before retirement. Judging by the vehement opposition to the current (poorly understood) changes, it is unlikely that Treasury will put compulsory preservation pre-retirement back on the table any time soon. And with current budget constraints, it will in any event not want to lose the hefty tax revenue it earns on early withdrawals.
And if that is the case, then the arguments defending compulsory annuitisation of provident funds at retirement just don’t hold water. Our “retirement framework” will be as save as ever.
