Pravin Gordhan's budget speech will have a significant impact on retirement funds and employers. The purpose of this note is to report on these changes and briefly comment on our assessment of their possible impact. The main points raised were:
Contributions to retirement funds
Contributions by employers to pension, provident and retirement annuity funds are not currently taxed in the hands of employees. From March 1 2012, these contributions will be deemed to be a taxable fringe benefit in the hands of the employee.
Individuals will be allowed to deduct up to 22.5% of their taxable income for contributions to pension, provident and retirement annuity funds, subject to a maximum deduction of R200 000 and a minimum of R12 000. This is a slight change from the current situation where a distinction is drawn between retirement funding income and non-retirement funding income.
The taxation of employer contributions in the hands of employees will have a significant impact on the investment savings of retirement fund members. The tax deduction regime of 7.5% of approved remuneration for pension contributions and up to 15% of non-retirement funding income will no longer be applicable from 1 March 2012, and it is anticipated that the application of a total of 22.5% of taxable income (as opposed to approved remuneration or non-retirement funding income) for all retirement contributions means that the percentage deduction will be applicable off a smaller base.
The minimum deduction is potentially beneficial for low paid workers as this allows them to benefit from the floor level tax deduction. The R200 000 cap on deductions makes sense from the government's perspective as beyond a certain savings level it is clear that an individual will not be dependent on the state in old age.
These changes are a small first step towards the possible introduction of the national social security fund. They can also be seen as the beginning of an alternative approach to the fund.
Effective removal of provident funds
Withdrawals at retirement from provident funds will be limited to one third of the accumulated share of fund. On balance this is probably a good move as it will reduce the possibility of individuals squandering their retirement benefits. It appears that legacy provident funds will be accommodated, so members should not attempt to cash in their provident funds as their rights will be protected.
Competition in Living Annuity Space
Currently only long-term insurers can provide living annuities. The list of service providers will now be extended to collective investment schemes and National Treasury's retail savings bond scheme. This will increase competition in the market which will be positive for consumers.
The final version of Regulation 28 is positive in that it recognizes new asset classes and takes some notice of recent changes in investment markets. The fact that the asset class limits will now apply at individual member levels will potentially have an impact on many members in retirement funds which offer individual member choice, as well as individual retirement annuity policies.
Taxation of lump sum benefits on retirement
Government will increase the tax-free lump sum on retirement from R300 000 to R315 000.
Revenue is exploring two incentivised savings schemes as alternatives to the interest income thresholds- one for housing, in order to secure a deposit for first-time homeowners and another for higher education.
National Health Insurance (NHI)
NHI will be phased in over 14 years. Revenue is expecting such funding options as a payroll tax payable by employers, an increase to the VAT rate or a surcharge on individual taxpayers' income. Further announcements will be made next year in the 2012 Budget.
Other matters that Treasury intend to engage the financial services industry on are:
- The compulsory preservation of retirement savings
- The need to build financial planning tools and information into member benefit statements
- The costs of retirement annuity funds.
A possible unintended consequence of the proposed changes will be to reduce the overall savings pool in the country. This will have a second order effect on job creation that has not been envisaged in the proposed changes. Less capital in retirement funds will mean less capital for job creation initiatives such as the Industrial Development Corporations' Development Bond. In addition, while the tax reductions may boost consumer spending, there will be less assets in the capital markets overall which implies less will be available for investment in job creating opportunities overall. A final, possible third order effect is that less money in capital markets reduces demand for these instruments, which in turn will reduce returns and further reduce the overall capital base.
The proposed changes will require further evaluation as well as engagement between the industry and the National Treasury over the next year.