The devil’s in the detail

In his 2013/2014 budget speech, Pravin Gordhan introduced changes that will have a direct impact on financial planning and the way that clients protect and accumulate their wealth. How do financial planning professionals incorporate these changes into existing financial planning principles? How do they make the most of opportunities offered by tax collecting authorities?

According to Alwyn van der Merwe, director of investments at Sanlam Private Investments (SPI), the Minister had little scope within which to manoeuver, given the weakness in both revenue and expenditure. "Although a lot was made of the R7bn tax concessions to individuals, indirect taxes are likely to generate R5.8bn. R1.2bn relief to the consumer is hardly exciting in a year where the prices of consumer goods appreciated by about 6% and the total revenue from income tax from individuals is R251bn,” said van der Merwe.

Arthur Kamp of Sanlam Investment Management (SIM) said that given weak GDP growth South Africa has no choice but to accept fiscal slippage, run larger deficits and let the debt ratio increase more than previously projected. But Treasury held off on hiking taxes, probably because it is wary of burdening an already struggling economy. "The underperforming economy made the fiscal maths hard,” said Kamp.

Retirement reform will come under review again this year, with emphasis falling on a number of key areas. For our purposes, there are two ‘days’ to highlight: ‘P-day’ and ‘T-day’. On P-day, preservation rules for all retirement funds will change (on or after 2015). On T-day, taxation rules and annuitisation requirements will be harmonised across all retirement funds (on or after 2015).

Kobus Hanekom, head of strategy, governance and compliance at Sanlam Employee Benefits, said a number of the changes made affect the employee benefits industry. The team, comprising Anton Swanepoel, Danie van Zyl, Lance Hoffman, Awie de Swardt, Carien Veenstra and Freddy Mwabi, made some observations.

From T-day, employer contributions to retirement funds will become a fringe benefit in the hands of employees for tax purposes, Hanekom and the team said. Individuals will be able to receive an annual tax deduction on employer and employee contributions to a pension fund, provident fund or retirement annuity (RA) up to 27.5% of the greater of remuneration and taxable income (which excludes RA or lump-sum income). A ceiling of R350 000 will apply.

This threshold has been increased from R300 000 and the age distinction in respect of those under 45 years (22.5% and R250 000), referred to in the 2012 budget, has been discarded. It is still not clear how this will affect defined benefit pension plans.

Ronald King, head: technical support services at PSG Wealth, said that retirement funds will be required to identify appropriate preservation funds for exiting members, who will be encouraged to preserve when changing jobs. They will be required to guide their members through the process of converting savings into a regular income after retirement, and to choose or establish default annuity products that meet appropriate principles and standards.

Hanekom and his team said that a number of preservation-related measures will be introduced, but there is as of yet no indication as to when this will take place.

Full vested rights with respect to withdrawals from retirement funds will be protected. Amounts in retirement accounts at the date of implementation, and growth on these, can be taken in cash (but the benefit will first be transferred to and then paid from a preservation fund) and will be subject to taxation based on the current principles.

From ‘P-day’, preservations funds will be used to manage and help contain cash withdrawal payments and payments resulting from divorces.

Retirement funds will be compelled to identify a default preservation fund or fund section and transfer members’ balances into that fund (or another fund) when members withdraw. "Retirement funds will be required to appoint non-commissioned planners to assist in this regard,” King said. "More competition will be promoted by allowing providers other than life offices to sell living annuities.”

An amount limited to the greater of the state old-age grant (OAG) or 10% of their initial amount transferred, excluding any portion to which vested rights apply, can be withdrawn annually from the preservation fund. Unused amounts can be carried forward.

According to King, preservation funds will no longer be subject to one withdrawal only. It is also proposed that investors be allowed to make similar annual withdrawals from retirement annuities should they be retrenched.

"From 2015, contributions to provident funds will be treated the same as contributions to other retirement funds upon retirement in that two thirds must be used to purchase a life annuity,” King pointed out. "This will not be applicable to contributions and fund values before 2015 or if the member was born before 1960.”

Annuitisation is another important area of focus as rules will be introduced from P-day. "The annuitisation requirements of provident and pension funds will be harmonised – members of provident funds will also be required to use two-third of the benefit to purchase a life annuity,” said Hanekom.

The new rules will apply only to contributions made to provident funds after P-day, as well as growth on these contributions. Existing balances in provident funds and growth on these will not be subject to annuitisation. Members of provident funds who are older than 55 years on the date of implementation will not be required to annuitise any of their balance at retirement, provided they remain in the same provident fund until they retire.

The means test for the old-age grant will be phased out by 2016 to lessen the impact on provident fund members. Meanwhile, the de minimis requirement for annuitisation will be raised from R75 000 to R150 000. Hanekom said that over time it would make sense to consolidate hybrid funds. Effectively, any biases in retirement fund rules that discourage individuals from working past retirement age of their funds will be identified and removed.

Living annuities will be eligible for selection as the default product, provided certain design tests on charges, default, investment choice and drawdown rates are met. This is a departure from the position taken in the technical discussion paper ‘Enabling a better income in retirement’, in which a fundamental restructuring of the annuities market was proposed, one of which was a compulsory guaranteed annuity in respect of the first R1.5 million.

For the first time, National Treasury made the point that it is the responsibility of trustees to guide members through the process of converting their defined contribution lump sum accumulation into an income, said Hanekom. An FSB directive will be issued to outline minimum requirements.

Trustees that make commission-free financial advice available to members on retirement, paid for out of the fund on a salaried basis, will be given some legal protection in respect of the choice of the default.

When it comes to fund governance, the duty of trustees to act independently and free from conflicts of interest will be strengthened by elevating PF Circular 130, which deals with the governance of retirement funds, to a Directive, according to Hanekom.

"The FSB will monitor trustee appointment and will help to ensure that trustees meet ‘fit and proper’ requirements,” he and his team pointed out. "The current FSB Trustee Toolkit may be elevated into a basic, independent, compulsory and free training kit for Trustees. The Minister will convene a trustee conference with a view to further strengthening the governance of retirement funds.”

According to King, trusts are definitely not the flavour of the month. Treasury has indicated that estate duty avoidance by trusts will be targeted in legislation. This is important in that it is the first clear indication that Treasury has back-tracked on the removal of estate duties. They will also remove the flow-through principle of trusts, resulting in income from trusts being taxed in the trust itself to be deemed to be ‘normal revenue’ in the hands of the beneficiary.

"It is also proposed that any payments to beneficiaries from offshore trusts will be fully taxable,” King said. "Before advice is provided to trustees, more clarity on the wording of legislation needs to be provided.”

No change to this tax was announced, and the exempt portion of foreign dividends for individuals is 25:40. This means that 15:40 of the dividend is included in the individual’s taxable income, said King, with the result that the maximum tax rate on foreign dividends is 15% compared to a fixed 15% on local dividends.

According to Jaco Gouws, product marketing actuary for Old Mutual South Africa rising funeral costs make funeral planning more expensive, but planners can highlight the fact that the estate duty abatement will remain unchanged at R3.5 million, while the capital gains tax (CGT) exclusion on death is still capped at R300 000.

"If a customer’s assets have grown at 10% a year and there is an increase in CGT from that growth, an updated estate and liquidity plan could show a need for increased liquidity,” said Gouws. "If not practically addressed, it could force the executor to sell assets that were intended for beneficiaries to create liquidity within the estate.”

According to Hanekom and his team, government intends to proceed with and introduce tax-preferred savings and investment accounts by 2015. All returns accrued within these accounts and any withdrawals would be exempt from tax. The account would have an initial annual contribution limit of R30 000 and the lifetime limit of R500 000 to be increased regularly in line with inflation. "The new account may coexist with the current tax-free interest income dispensation,” said Hanekom.

"The current interest exemption has been inflation-adjusted in this budget, possibly for the last time.”

King noted that the medical tax credit has been increased from R230 per month for the first two beneficiaries and R154 per month for any additional beneficiaries to R242 and R162 respectively. Taxpayers older than 65 can still deduct their full medical expenses for this financial tax year.

What is clear is that financial planners will have to be ofay with the changes proposed by Treasury, so as to give the best possible financial advice to clients. At the same time, there are some opportunities that should be capitalised on – it is not all ‘bad news’. "The Minister did what he could in a tough environment,” said van der Merwe. "However, if economic growth disappoints in future he may well be forced to raise taxes if political demands limit his ability to control the growth in expenditure.”