Provident fund members stand to gain a significant income boost from tax law changes – GTC Wealth Management
The changes to legislation regarding provident fund cash lump sums at retirement hit the headlines recently, with very little understanding of the debilitating impact the existing practice for the majority of provident fund members has on long-term retirement earnings.
This is the view of Martin Wagenaar, a wealth management consultant at GTC.
The contentious changes aim to bring provident fund payouts in line with those of pension funds, which can pay out a maximum of one third of the benefit as a cash lump sum on retirement, subject to certain limitations, with the balance paid out in monthly instalments.
“We hope that government uses the opportunity to clarify the potential benefits to pensioners,” says Wagenaar. “We support government’s efforts to promote greater financial responsibility in retirement as all too many South African pensioners find themselves in a financial bind.”
Wagenaar believes that the proposed change to the provident fund retirement benefit payment methodology is both prudent and well thought out in the proposed implementation of the changes. The vociferous opposition to the amendments caused undue panic, especially if it is considered that the effect would actually only be felt in many years’ time. This is because the proposed changes would have only applied to provident fund members who were younger than 55 on March 1 this year, with those over 55 still able to withdraw their full fund benefit on retirement if they so choose.
In addition, the incremental nature in which the annuitisation would be introduced, and the fact that new accrued values less than R247 500 could still be taken in cash, postponed the impact of the proposals far into the future.
“Another reason that provident fund members should be celebrating is that they can now enjoy tax relief on their direct contributions, which is something that pension fund members have always had access to,” Wagenaar continues. “The overall contribution rate allowed against tax is now a generous 27.5%, with the only downside that a cap of R350 000 per annum applies on all contributions made to retirement funds, which affects the higher income earners quite significantly.”
The postponement of two years which government has been pressured into before implementing the limit on lump sum payouts will hopefully allow enough time to drive home the message to South Africans that it is in pensioners’ interests to receive an annuity payment.
Wagenaar says that the real benefit can be illustrated quite effectively through a simple comparison between taking a full cash lump sum compared to when pensioners can only take one third of retirement savings as a cash lump sum. The impact in this example below is a difference of a staggering R715 200 over a 20 year period.
The example assumes that a pensioner retires (age 65) with retirement savings of R3 million. This would be a reasonable retirement capital amount for a person that had accumulated the retirement savings over a long period such as 25 odd years, paying R5 000 per month into their retirement fund.
In the case of a pension fund, it is assumed that one-third of the pension is withdrawn and the remainder is then placed in an annuity fund. The pensioner would be subject to tax of R117 000 on the cash portion, and earn annual net income of R144 150 from the annuity and cash holdings.
“Should the lump sum be withdrawn from a provident fund, tax of R832 500 would be levied, with annual income being only R108 375,” says Wagenaar. “Taken on a monthly basis, the pension fund member would earn R12 010 per month, compared to only R9 030 for the provident fund member thereafter.”
The example reveals that it is the difference in this income – over the average 20 year retirement period – that produces the result of pension fund members earning R715 200 more than their provident fund counterparts who withdrew their full lump sum at the outset.
Wagenaar says that stark examples such as this one would certainly help to move the debate around the annuitisation of provident fund benefits forward. In the real world the difference would be even more severe as it is a well-known fact that most retirees are not able to use a large lump sum wisely and the funds are often squandered.
“It’s important to remember that it is also not only government’s responsibility to engage with and inform those who are not in favour of the change, but it is also the financial services industry’s role too,” cautions Wagenaar. “Engagement and consultations with company provident fund members should be taking place to educate members about the long-term financial benefits they will derive from the proposed changes.”
It is not often that changes in tax laws produce a direct benefit to employees. In this case, the benefits are clear and should be embraced.