Being highly tax-efficient vehicles for retirement savings, retirement funds play an important role in most people’s investment portfolios. But the retirement funding industry is heavily regulated meaning that several restrictions and limitations apply to the money saved in approved retirement funds which are important to understand before committing your savings to such a vehicle. In this article, we take a closer look at the legislative environment of retirement funds and what you should know when investing in these types of funds.
- Highly regulated environment
As mentioned at the outset, approved retirement funds, which include pension, provident, preservation and retirement annuity funds, operate in a highly regulated environment, with the primary piece of legislation being the Pension Funds Act, while older insurance-based retirement annuities fall under the auspices of the Long-term Insurance Act. Both the Income Tax Act and the Divorce Act have an important bearing on retirement funds, particularly when it comes to understanding the tax implications of investing in such funds and the calculation of pension interest on divorce. Other relevant information includes the Maintenance Act, FAIS Act, and the Financial Sector Regulation Act, amongst others.
- Occupational versus individual funds
Occupational retirement funds include pension and provident funds which are made available by employers to their employees or certain categories of employees to allow them to save towards their retirement. Contributions to these funds can be made by both employees and employers, depending on how the fund has been set up by the company. When setting up a group retirement fund, the employer can determine which categories of employees qualify to join the fund, provided that no employees are unfairly discriminated against. Where a company has set up an occupational fund, it is generally made a condition of employment that qualifying employees and all new and future employees join the scheme. While there are key distinctions between a provident and a pension fund, the term ‘pension fund’ is generally used as a broad term that includes both types of funds. Where a person does not qualify to join an occupational fund for whatever reason, or where a person wishes to contribute privately to a retirement fund over and above their occupational fund contributions, they can do so through a retirement annuity fund. Legislation has recently been amended so that the options at retirement in respect of pension, provident and retirement annuity funds have been harmonised. With effect 1 March 2021, when retiring from a pension, provident or retirement annuity fund, a member can commute up to one-third of his fund while the remaining two-thirds must be used to purchase an annuity income.
- Management of the retirement fund
Every registered retirement fund is required to operate in accordance with the rules of the funds and the provisions of the Pension Funds Act, with the control and oversight functions being fulfilled by a board of trustees in terms of sections 7C and 7D of the PFA as well as applicable common law. Retirement fund trustees have a duty to manage the retirement fund in the best interest of the member to ensure that the funds are properly managed and invested with due care, diligence and good faith. Their role includes ensuring that contributions are paid on time, the fund’s assets are appropriately administered, and that the operation of the fund is compliant with the scheme rules and applicable legislation. Trustees are required to attend regular training and, to the extent that they lack expertise, are required to seek expert advice from industry experts such as actuaries, accountants and lawyers.
- Distinction between insurance and LISP
While many new generation retirement annuities are housed on a LISP platform in the individual investor’s name, older retirement annuities are in fact insurance policies which take the form of a contract between the insurer and the policyholder, and it is important to understand the distinction. A unit trust RA is owned by the individual investor and is investment-linked, meaning that the investor can choose which funds to invest in, subject to the limitations imposed by Regulation 28 of the PFA. Investors are able to increase or decrease monthly contributions with no fear of penalty and can make ad hoc lump-sum contributions at any time. The costs of investing in a unit trust RA are significantly less than an insurance-based RA policy and the difference in cost can have a considerable impact on your accumulated savings in the long term. The ability of investors to elect and switch underlying funds plays an instrumental role in the long-term performance of their invested assets. Further, the financial advisor on a unit trust RA does not charge upfront commission but instead earns an annual advice fee which is a negotiated percentage of the underlying investment. On the other hand, an insurance RA is a policy generally sold by a broker to the policyholder on which he earns an upfront commission that is effectively borrowed from the policyholder’s future investment with interest charged. The insurance company has full control over the investment of the funds and the policyholder has very little insight into how the money is vested. Generally speaking, a policyholder will be penalised for the premature cancellation of the policy or for non-payment of a premium depending on how long the contract has been in force, the remaining term to maturity and the terms of the contract.
- Retirement fund contributions
Those investing in approved retirement funds receive significant tax benefits for doing so. Firstly, up to 27.5% of an investor’s taxable income up to an annual maximum of R350 000 can be invested towards a retirement fund on a tax-deductible basis, meaning that the investor can claim the tax back from SARS when filing his annual tax returns. When calculating one’s taxable income, it is important to include your salary, rental income, dividends earned from REITS, as well as investment income. An investor can contribute to as many retirement funds as he likes – including pension, provident or RA funds – although the tax-deductibility of contributions will be calculated cumulatively across all the funds. In addition to the tax benefits provided on retirement fund contributions, investors do not pay tax on investment returns earned such as interest income, dividends and capital gains.
- Offshore exposure
A perceived shortcoming of retirement funds is the limitations imposed by Regulation 28 of the Pension funds Act. This piece of legislation essentially limits asset managers’ allocations of retirement savings to certain asset classes, including equities, property, and foreign assets. Recently, the amount of allowable offshore exposure was increased from 30% to 45%, with the 10% Africa component falling away completely. This new limit enables investors to diversify their retirement investments and hedge their savings against the rand and local economy where appropriate.
- Accessing your retirement funding capital
One of the key features of a retirement fund is that investors cannot access their capital before the fund’s formal retirement age other than in the case of financial emigration or early retirement due to ill-health. In the case of retirement annuities, investors cannot access their capital before the age of 55, whereas in the case of pension and provident funds the retirement age as per the scheme rules will be applicable. Being the only exception to this, preservation fund legislation allows investors to make one full or partial withdrawal prior to the age of 55. Where an investor makes a partial withdrawal, he will not be able to make another withdrawal relating to that contribution, and the balance of the preservation funds will have to remain invested until retirement or death.
- Retrenchment benefits
If you lose your job as a result of your employer ceasing operations or are made redundant as a result of general operational requirements, any lump sum from an occupational fund is regarded as a retrenchment benefit for tax purposes. When leaving an occupational retirement fund due to retrenchment, the first R500 000 of your combined severance and retrenchment (retirement) benefit will be free from tax, whereafter any further withdrawals will be taxed as per the retirement tax tables.
- Divorce and your retirement funds
The Divorce Act makes provision for the calculation of a pension interest which allows divorcing spouses to share in each other’s retirement benefits at the date of divorce rather than having to wait until formal retirement to receive their share of the asset. The term pension interest is a notional amount based on the benefit that a member spouse (i.e. the spouse who is a member of a retirement fund) would have received at the date of divorce. Pension interest is calculated at the date of divorce, keeping in mind that the member spouse must be a registered member of the retirement fund on the date of divorce. In the case of pension and provident funds, if a member spouse resigns from her employment or retires from the fund before the date of divorce, there is effectively no pension interest, and the benefit accrues to her – whereafter it will be dealt with as any other asset in the estate. The method of calculating the pension interest is dependent on the nature of the matrimonial property regime. Where a couple is married out of community of property, each spouse will have a 50% claim against the other spouse’s pension interest. Where couples are married with the accrual system, the value of the pension interest in their respective retirement funds will be taken into account when calculating the accrual at divorce. In respect of pension, provident and preservation funds, pension interest is defined as the benefits a member of the fund would have been entitled to in terms of the scheme rules had his membership ceased on the date of divorce as a result of resignation. In respect of retirement annuities, the pension interest is the total amount of the member’s contributions to the fund up to the date of divorce, together with the total amount of annual simple interest on those contributions calculated at the prescribed rate.
- Death and your retirement funds
As a member of a retirement fund, you will be asked to indicate who your nominated beneficiaries are. However, many retirement fund investors make the mistake of assuming that the nominated beneficiaries are guaranteed to receive the death benefits when the member passes away, whereas this is not the case. Section 37C of the Pension Funds Act governs the distribution of retirement fund benefits if a member dies prior to formal retirement. This section places a duty on the retirement fund trustees to ensure that the member’s death benefits are distributed fairly and equitably amongst his financial dependants and/or nominees, meaning that a member’s nominated beneficiaries may not necessarily receive a portion of the death benefit. This is because a member’s death benefits must be used to provide for the member’s surviving spouse, children, and other financial dependants in the event of his death. As retirement fund death benefits are paid directly to the member’s beneficiaries and/or nominees, these assets fall outside of the deceased estate and are not subject to estate duty.
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