Considering statistics show that approximately one out of every three marriages end in divorce, it is not surprising that the issue of the division of retirement fund benefits at divorce is quite topical.
While many financial planners are aware that there have been changes in this regard, they may not be entirely sure about how to advise their clients as all the issues and considerations are not set out in a single piece of legislation and there are ongoing amendments to the legislation in this regard. There are three Acts, namely the Divorce Act, the Pension Funds Act and the Income Tax Act that deal with the issue.
The Income Tax Act was amended by the Taxation Laws Amendment Act on 22 July 2008, and will be further amended by the Revenue Laws Amendment Bill later this year. The Income Tax Act and the Pension Funds Act will be amended by the Financial Services Laws General Amendment Bill, which should be promulgated shortly.
The Divorce Act provides that upon divorce, the court may grant an order in terms of which the non-member spouse is entitled to a share of the member's ‘pension interest' when the retirement fund benefit accrues to the member. Pension interest in respect of pension funds and provident funds is defined as the benefit to which the member would become entitled to in terms of the rules of the fund if he/she had effectively resigned on the date of the divorce. Pension interest in respect of retirement annuity funds is defined as the total amount of contributions plus simple interest at the prescribed rate (currently 15.5% pa) and therefore does not take into account the actual growth in the fund.
In the past, the non-member was only entitled to the benefit when the member resigned, retired or died, and did not share in any of the fund's growth. To allow for a ‘clean break' principle, a new provision was inserted into the Pension Funds Act, effective on 13 September 2007, allowing the non-member to receive the benefit within 60 days of the divorce either as a lump sum or transfer to an approved retirement fund.
The amendments to the Pension Funds Act did not make it clear whether this new provision applies retrospectively to divorce orders granted prior to 13 September 2007. The Pension Funds Adjudicator ruled in the Cockroft case that it does apply retrospectively. The Financial Services Laws General Amendment Bill will amend the Pension Funds Act by providing that any pension interest that was assigned to a non member spouse in terms of a divorce order granted prior to 13 September 2007 will be deemed, except for the purposes of the Income Tax Act, to accrue to the non member on 13 September 2007. This will clarify the position regarding retrospectivity.
The Financial Services Laws General Amendment Bill will amend the Pension Funds Act to set out the manner in which the fund must deal with the divorce order. Within 45 days of the non-member spouse submitting the divorce order to the fund, the fund must request the non- member to elect whether the benefit must be paid as a lump sum or be transferred to another fund. The non-member must, within 120 days of such request, make an election and provide the fund with the appropriate details. The fund must make payment or effect transfer within 60 days of the non-member's election.
The Financial Services Laws General Amendment Bill proposes two further amendments to the Pension Funds Act which relate to the definition of pension interest in the Divorce Act. The first amendment relates to the calculation of the pension interest in respect of retirement annuity funds. The amendment will have the effect that the rate of simple interest on the contributions cannot exceed the fund return.
The second amendment relates to divorce orders against preservation funds. The proposed amendment provides that the pension interest in respect of a preservation fund shall be the portion of benefits to which the member would have been entitled to had the membership of the fund been terminated on the date of divorce. This amendment appears to have the effect that funds will now be bound to make payment in respect of divorce orders against preservation funds.
The Taxation Laws Amendment Act amended the Income Tax Act by inserting a formal definition of a preservation fund, and which will allow the non-member to transfer the benefit to a preservation fund of his or her choice.
The Income Tax Act provides for the manner in which the share of the pension interest awarded to the non-member must be taxed. Currently the member is liable for the tax on the lump sum, but may recover it from the non-member. In terms of the Pension Funds Act, the tax payable in respect of the payment of the lump sum may be paid from the member's benefit in the fund.
The Revenue Laws Amendment Bill, which was released by National Treasury for public comment on 1 August 2008, proposes to amend the Income Tax Act so that the non member spouse becomes liable for the tax on benefit if he/she elects to take it as a lump sum. The lump sum benefit will be taxed as a withdrawal, The proposed manner of taxing a withdrawal is a tax free portion equal to 50% of the relevant tax year's threshold (this year it is R46 000), with the balance being taxed according to the normal tax tables of the relevant year. This withdrawal amount will be ring fenced from the non-member's other income and a different marginal rate in respect of the withdrawal amount may therefore apply. If the non-member elects to transfer the benefits to another approved retirement fund, including a preservation fund, no tax will be payable on transfer. These amendments are proposed to become effective on 1 March 2009.
This is a merely a summary of some of the extensive legislative changes. It is important for financial planners to keep abreast of further changes as they develop and become law, and be able to advise clients on some of the practical implications. It is also important to note that retirement funds will first have to amend and have their fund rules approved by the FSB before being able to effect these legislative changes.
The value of appropriate and trusted advice to a client who is in the process of finalising the division of assets in a divorce matter, or has been previously divorced, cannot be under estimated.
(This article first appreared in the Money Marketing Newsletter)
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