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Old Mutual Retirement Reform Dialogue Session Q&A

06 November 2008 Old Mutual

Section 1:

 

Discussion on Proposed Reforms

David O’ Brien: Head of Retirement Reform, Old Mutual

 

 

 

1. Is the current South African retirement system inadequate?

There is a false perception that the low replacement ratios experienced by the average South African member are the results of an inadequate” system, and specifically the participants within the system. Research has shown that the low replacement ratios experienced by South Africans are largely caused by the practice of allowing members to cash in their retirement savings upon exiting jobs. If the current members of the industry had savings for their entire careers, then their replacement ratios at retirement would be greater than 75%, in excess of international norms.

If the cost of providing retirement benefits as a percentage of assets – the measure most often used in this cost regard – is measured against a higher level of savings brought on by improved preservation, then the costs of provision would also be on a par with international best practice.

 

2. How important will the implementation of the new framework be for the pensions industry in South Africa?

A primary goal of the reforms is to bring the approximately 3 million people who are formally employed, but not in pension schemes into the system. This will be a massive undertaking for the country.

3. Will everyone have to contribute to the National Social Security Fund?

The proposal is that all employed people will have to contribute a defined percentage of salary.

4. Will individuals be able to contract out of the National Social Security Fund?

The Current discussion documents offer limited contracting out.

 

5. Will employers have to contribute to the National Social Security Fund and a private fund for their employees?

Minimum contribution of DC % of earnings (to a ceiling) to NSSF or opt out fund depending on model.

6. Will employers have to contribute to the National Social Security Fund on behalf of employees in addition to existing retirement contributions?

No, there is currently no compulsory provision. Any National Social Security Fund contribution could be offset against current contributions, provided that the total contribution is at the minimum of the compulsory rate.

7. Will there still be tax advantages to saving for retirement?

Yes, there will be – Government has made it clear that they wish to encourage savings and do not wish to adversely affect the current strong retirement savings industry.

There may be capping of tax incentives for higher-income individuals, however, this is not clear and may go hand in hand with other positive aspects, e.g. a lifetime cap on incentives rather than an annual limit.

8. How will a wage subsidy work?

A wage subsidy is still under discussion and is likely to be administered as a rebate to employers through the SITE system. Such a subsidy may fully offset the social security contribution for low-income employees.

9. What about accrued benefits under the existing framework?

Accrued benefits will not be removed as per the Ministers.

10. Is it a good idea to continue saving for retirement whilst the reforms unfold?

Yes:
a. It is not clear yet what the impact of the reforms will be and when they will be implemented. b. Delaying saving for retirement is costly and the negative impact is likely to far outweigh any impacts of the reforms.
c. Providing suitable retirement savings vehicles for employees is an essential part of being an employer of choice.
d. The reforms are likely to require compulsory retirement provision.

e. Accrued savings under the existing framework are highly likely to be preserved.

The reforms intend to increase savings.

11. Will the reforms lower administration costs of pension funds?

 

Greater membership from compulsory participation will spread the industry costs wider, and will allow the private sector to demonstrate its global standard efficiencies.

There is an argument that passive investments are cheaper than active investments. This is factually correct. However the critical outcome is the net return earned by the member after charges. In the same way that small charges can erode final fund value, then small regular out-performance can significantly enhance fund value.

12. What impact will the proposed legislation have on the private retirement fund industry?

Old Mutual supports the concept of compulsory membership, however there is concern at the source of this saving. Retirement saving is deferred consumption. People save from the income producing years to cover the non-income producing years. The arrival of an 8-10% mandatory contribution will appear very much like an unaffordable tax, particularly at this stage of the economic cycle. The employee is unable to pay; the employer will not be able to bear the increased cost of employment. This leaves government to subsidise the members. However the potential cost of this subsidy is still being hotly debated within government.

While the government discussion has included the concept of an opt out to an industry fund, it does not make allowance for the small businessman. They will have no choice but to default to the NSSF (NOTE – NSSF not defined before this use here). Currently many small business owners receive their pension fund service from one of the many open funds in the industry. We believe that these funds have a valid role to play in the future.

Additionally the concept of splitting away the lower income earners to a NSSF will remove the current cross-subsidy between higher earners and lower earners that characterises many of the current industry schemes. Also given that one of government’s aims is to reduce the cost of administration. The complexity inherent in managing the finances of members across multiple tiers and vehicles will cause a real increase in costs to all participants in the system.

There has been significant concern across the country at the prospect of members losing control of their pension funds to a faceless government entity. We believe there is a model where government can set the parameters of the system, but that delivery is achieved through regulated private entities that compete on service as well as price.

Section 2:

 

Impact of Possible Changes to the Risk Benefits Market

John Kotze: Group Assurance Executive, Old Mutual Corporate

 

1. What are “Group Risk Benefits”?

 

Group Risk Benefits are financial benefits provided to a group of members, with such benefit paid on a member’s death or disability while a part of that group.

The most common definition of a group is a group of company employees, but any insurable group can be covered provided the group has a particular relationship in common that is stronger than their need for insurance. Other examples of groups that apply for risk benefits include: trade unions, professional bodies and borrowers from credit institutions.

In most instances the financial benefits are provided through an insurance policy, but it is possible for the group to self-insure their risk benefits. A stokvel is a good example of a form of self-insurance arrangement.

The most common financial benefits are paid on the death or disability of an employee.

2. What cross subsidies exist already in the provision of these Group Risk benefits – and which do not exist?

 

The nature of group cover is such that most cross subsidies are unavoidable, but equally the simplicity of such group cover arrangements is an attractive feature, where everyone in the company pays the same rate as a proportion of salary.

The younger lives are cross-subsidising the older lives.

The females are cross-subsidising the males.

The high-income lives are cross-subsidising the low income lives

3. How can the Group Risk benefits market contribute to the Reform process?

Risk benefits are critical to reform – on a current projection less than half of South Africans will make retirement due largely to the HIV/Aids epidemic. Disability is also a big risk to people in employment.

Current group risk market currently ensures approximately 5 million people in employment.

4. In what other areas does the Group Risk market complement the Reform process?

 

Bringing insurance to more people: The earlier comment about bringing 3 million people, who are currently in formal employment, into a pension system can be restated here under the Risk Benefits section. The whole point about insurance is that it enables people to fulfil an outcome or meet a need that might not otherwise be fulfilled or met, such as paying for the costs of a funeral, sustaining a lifestyle even while disabled (“differently able”) or supporting your children to receive the education you wish them to receive. Insurance works best when there are as many people as possible being insured.

Effective claims and risk management: This comment will be function of the method chosen to bring about a fair and equitable benefit and contribution structure for all participants. The principles of administrative efficiency and sustainability are also high on the minds of decision-makers, and the existing Group Risk market provides a good example of how this balance can be met, with a member’s incentive to claim being balanced by an employer’s or trustees’ incentive to keep risk costs down so that more contribution can be allocated to retirement saving. A poorly managed structure will be to everyone’s disadvantage at the end of the day.

The area of disability claims management is a case in point, with claimants, employers and insurers all working together to support the aim of the returning people with disabilities to work.

 

5. So in what ways could such a Risk Benefits structure be introduced?

There are a variety of options, each of which will be assessed against the various Reform principles and criteria (such as equity, pooling of risks, administrative efficiency, mandatory participation, solidarity, ease of transition, costs, individual rights to choice, adequacy, sustainability and robustness).

These options include, amongst others:

· the concept of the new National Social Security Fund that could then provide everyone with the first tranche of risk cover, essentially self-insured by the government; or

· requiring all insurers to participate in a risk equalisation mechanism for risk benefits, which reallocates the cost while best retaining the incentive for good risk and claims management .

Ultimately, the Reform process should adopt the option that best meets all the criteria listed above.

Section 3:

 

Legal & Tax Complexities

Rod Stevenson: Senior Advisor, Product Solutions Legal, Old Mutual Corporate

1. What changes have already been effected?

From tax periods after 1 March 2007 the tax on the interest, rental and foreign dividend earnings of retirement funds has ceased.

From 1 October 2007 the average rate tax regime applicable to lump sum benefits, arising from retirement or death, has been replaced by a scale based on the size of the lump sum, and the tax-free concession was increased to a lifetime amount of R300 000.

Taxation of lump sums at retirement and on death

Lump Sum

Tax Liability

R0 – R300 000

0%

Exceeding R300 000 but not exceeding R600 000

18% of Taxable Income

Exceeding R600 000 but not exceeding R900 000

R54000 plus 27% of taxable income exceeding R600 000

Exceeding R900 000

R135 000 plus 36% of taxable income exceeding R900 000

The scale is applied cumulatively to retirement / death benefit lump sums over the lifetime of the member.

2. What further changes are envisaged?

The scale basis of taxing retirement lump sum benefits will be extended to pre-retirement lump sum cash withdrawals.

Lump sum Tax liability

R0 – R22 500 = 0%

R22 500 – R600 000 = 18% of the amount above R22 500

R600 001 – R900 000 = R103 950 + 27% of the amount above R600 000

R900 001 and above = R184 950 + 36% of the amount above R900 000

This scale is applied on a cumulative basis.

The tax free concessions at retirement / death will be modified to disincentivise cash withdrawal benefits after 1 March 2009 by reducing the R300 000 tax free amount by uses of the tax free R22 500 and by amounts of withdrawal benefits taken in cash.

The Budget Review of 2008 indicated there were unfinished aspects to the shift to the FSB from SARS of control over all regulatory matters relating to retirement funds. There is scope for further developments here.

While the lump sum benefit and investment roll-up parts of retirement fund tax have received attention, the contribution side has not. The 2008 Budget Review indicated that contribution deductibility will more fundamentally receive attention as part of the retirement reform initiative.

3. What changes have been made to the payments of divorce awards from retirement funds?

The “clean break” principle allowing a non-member divorcee access to court awards immediately rather than when the member divorcee exited the fund was introduced from 13 September 2007.

The amount of the divorce award is still taxable in the member divorcee’s hands. This will change from next year to taxation in the non-member’s hands.

A process set out in statute entitles the non-member spouse to elect that the portion of the member divorcee’s pension interest awarded by a divorce court be paid in cash or transferred to another fund.

The award is taxable in the member divorcee’s hands whether paid in cash or transferred. The member divorcee can recover tax on the award from the non-member divorcee. In most cases the tax will be as for withdrawal benefits without any tax-free portion.

The “clean break” process has been extended to divorce awards made before 13 September 2007 by the Financial Services Laws General Amendment Act. What future changes are envisaged in the Revenue Laws Amend Bill, 2008?

The proposal is to tax the divorce award in the non-member divorcee’s hands from 1 March 2009. Transfers to other funds will then be tax-free.

Tax from 1 March 2009 will be in terms of the new regime for taxing pre-retirement withdrawal benefits that will be introduced at the same time.

4. What do the new definitions of “pension preservation fund” and “provident preservation fund” achieve?

The Income Tax Act now recognizes and provides a legislative framework for the existence of pension preservation funds and provident preservation funds. It also removes certain restrictive entry criteria that discouraged preservation of benefits.

The most important new provision is that eligibility for membership is no longer based on the employer being a participating employer of that preservation fund. An employee may elect to preserve benefits in a preservation fund of choice.

The upper age of 70 for retirement is removed - this will be determined by the member in conjunction with the fund rules

A non-member spouse may transfer the divorce award to a preservation fund.

unclaimed benefits may be transferred to a preservation fund

5. What is the new regime for living annuities?

A new definition of living annuity is introduced into the Income Tax Act. It is seen as a right of a member or former member to an annuity purchased from a person on or after the retirement date. A living annuity is seen as equivalent to an annuity and is taxed as an annuity.

The practice notes governing draw down limits will be replaced by method or formula prescribed by the Minister i.e. by regulation.

The value of the annuity is determined solely by reference to the value of assets that are specified in the annuity agreement and is not guaranteed.

Assets may be paid as a lump sum if the value at any stage falls below the amount prescribed by the Minister (small annuities).

On death of the annuitant the balance of the assets may be paid to beneficiaries as an annuity or a lump sum. If there are no beneficiaries, it may be paid to the deceased’s estate as a lump sum.

This is intended to remove the concern arising from recent case law that a living annuity is not a true annuity.

6. What changes have been made to the death benefit provisions in Section 37C of the Pension Funds Act?

Previously payment of a death benefit to any trust for the benefit of a beneficiary was deemed to be payment to that beneficiary. This has been replaced by a provision that deems such payment to be made to a beneficiary if the payment is made to

a trustee nominated by the member

a trustee nominated by a major dependant or nominee

a trustee nominated by a person recognized in law or appointed by the court as responsible for managing the affairs or meeting the daily care needs of a minor dependant or nominee, or managing the affairs or meeting the care needs of a major unable to manage his affairs or meet his daily care needs.

a person recognized in law or appointed by the court as the person responsible for managing the affairs or meeting the daily care needs of a dependant or nominee.

a beneficiary fund. No such payment may be made to a beneficiary fund on or after 1 January 2009 if that fund is not registered.

The “beneficiary fund” is a new sub-category of “pension fund organisation”. All beneficiary funds established on or after the commencement date of the Financial Services Laws General Amendment Act must register under the Pension Funds Act.

7. What tax provisions are envisaged for beneficiary funds?

Payments from a beneficiary fund, which has received death benefits to administer, will be deemed income in the beneficiary’s hands.

To the extent that the benefits paid are made up of amounts previously transferred from a trust, this will not be deemed to be income.Where lump sum benefits are paid to a beneficiary fund on death of a fund member, no lump sum benefit will be deemed to have accrued on such payment.

8. What does the new definition of “unclaimed benefit” in the Financial Services Laws Amendment Act cover?

It includes a benefit; or an annuity or pension; or a surplus apportionment payment; or liquidation payment; which is not paid by a fund to a member, former member or beneficiary within 24 months of the date in the rules on which it became due and payable.

It excludes a benefit due to be transferred as part of a section 14 transfer where an annuity is purchased or a section 37C death benefit not paid within 24 months from date of death of a member or such longer period as may be reasonably justifiable by the board of the fund.

 

 

9. Will unclaimed benefits in retirement funds have to be transferred to unclaimed benefit funds?

This is not apparent from the legislation, but we understand that regulation under the Pension Funds Act may impose this obligation.

The legislation would appear to allow any provident preservation fund to accept unclaimed benefits from any provident fund and any pension preservation fund to accept unclaimed benefits from any pension fund. However, it is our understanding that the regulators will require that preservation funds receiving unclaimed benefits will have to be set up exclusively for unclaimed benefits.

 

10. What tax provisions will apply to unclaimed benefits in terms of the Revenue Laws Amendment Bill, 2008?

Taxed:

An unclaimed benefit that was previously taxed and transferred to a preservation fund can be withdrawn from the transferee preservation fund with tax free concessions on withdrawal, death and retirement.

Untaxed benefits:

A provision to defer accrual of withdrawal benefits for tax purposes until payment or transfer to another fund means that unclaimed benefits from 1 March 2009 can be transferred untaxed to the preservation fund and can be taken as a withdrawal, retirement or death benefit thereafter and taxed as normal withdrawal benefits

Quick Polls

QUESTION

The South African authorities are hard at work to ensure the country is removed from the global Financial Action Task Force grey-list by February or June 2025. What do you think about their ongoing efforts?

ANSWER

But what about the BRICS?
Compliance burden remains, grey-list or not.
End-2025 exit is too optimistic.
Grey-list is the new normal.
Too little, too late.
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