There is going to be heated debate in retirement planning circles as a result of the proposed amendment to implement annuitisation requirements on provident funds with effect from 1 March 2015.
Don’t panic. National Treasury has observed the vested right of provident fund members to be exempt from the new requirements. Furthermore, members of provident funds who are older than 55 on 1 March 2015 will not be affected by the amendments.
Types of funds
There are three basic types of retirement funds in the South African retirement system: pension funds, provident funds and retirement annuity funds.
For individuals who change employers, there are preservation funds that hold retirement savings until retirement.
Contributions to retirement funds
Employer contributions to pension funds and provident funds are tax deductible up to certain limits. These amendments and the capping of retirement fund contributions have been covered in previous articles.
Payouts from retirement funds
Payouts from a retirement fund take the form of a lump sum or an annuity. A lump sum will be taxable according to the retirement tax tables contained in the second schedule while an annuity will be taxable at the recipient’s marginal tax rate.
Annuitisation
Pension and retirement annuity fund members are already bound by a mandatory annuitisation requirement that requires the members to annuitise at least two-thirds of their fund interests upon retirement.
However, provident funds currently enjoy the advantage in that members are not required to annuitise any portion of fund savings. Most provident fund members choose to receive their retirement interests as a lump sum upon retirement.
A de minimis exception overrides the mandatory two-thirds annuitisation requirement if the member’s fund is less than R75 000 at retirement.
Preservation funds allow individuals to preserve their retirement savings when changing employers. Pension preservation and provident preservation funds cannot accept contributions from members; these funds can only accept transfers from (employer-provided) pension and provident funds.
In general, no tax is levied on the transfer of retirement savings from one fund to another.
However, due to the lack of annuitisation requirements in provident and provident preservation funds, transfers of retirement savings to those funds are taxed.
The absence of mandatory annuitisation in provident funds means that many retirees spend their retirement assets too quickly and face the risk of outliving their retirement savings.
The new annuitisation rule: effective 1 March 2015
From 1 March 2015, any person retiring from a provident fund or provident preservation fund cannot receive a lump sum upon retirement of more than one-third of their retirement interests. A compulsory annuity will now be required for the remaining two-thirds of their retirement interests. There will, however, be protection of historic vested rights within a provident fund.
However, to protect existing vested interests:
- balances in provident funds as at 1 March 2015 (and any subsequent growth thereon) need not be annuitised;
- if a provident fund member is older than 55 years of age as at 1 March 2015, the mandatory annuitisation requirements will not apply to contributions to the fund together with any growth thereon, made by that person as a member of the fund, as at the effective date.
Provident funds will maintain separate accounts in respect of a member under the age of 55 as at 1 March 2015 (in order to separate pre- and post-1 March 2015 contributions together with related growth).
Separate accounts need not be maintained by a provident fund for:
- members over age 55 as at 1 March 2015 as no annuitisation is required; and
- members joining a provident fund on or after 1 March 2015 as full annuitisation is required.
Example 1:
Provident fund member older than age 55 on 1 March 2015
Facts: 
Member T of the United Provident Fund is 56 years old on 1 March 2015, at which time Member T’s fund interest is R400 000. Member T continues to contribute to the provident fund and retires at age 64. On that day, Member T’s retirement interest is R750 000.
Result 
Member T will be able to take the entire amount as a lump sum at retirement (as under pre-existing law). The provident fund need not keep split accounts for Member T.
Example 2 
Provident fund member younger than age 55 on 1 March 2015
Facts: 
Member W of Open Provident Fund is 54 years old on 1 March 2015, at which time Member W’s fund interest is R450 000 with this amount increasing by R150 000 by the year 2020. Member W also continues to pay R200 000 in contributions to the fund after 1 March 2015 until 2020 with related growth amounting to R50 000. The final retirement interest in 2020 is R850 000. Fund administration: Open Provident Fund must maintain two separate accounts for Member W. One account in respect of the pre-1 March 2015 contributions and any growth thereon (R450 000 + R150 000), and another account in respect of the post-1 March 2015 contributions and related growth (R200 000 + R50 000).
Result
The pre-1 March 2015 contributions plus any growth thereon (R450 000 + R150 000 = R600 000) can be freely withdrawn as a lump sum.
The remaining R250 000 is subject to mandatory annuitisation. Member W may only take one-third of the R250 000 as a lump sum, while the remaining two-thirds is subject to annuitisation.
Protection principles will apply irrespective of whether the retirement interest remains in the provident fund or whether the retirement interest is transferred to another retirement or preservation fund.
If a provident fund member wants to transfer the member’s retirement interest to another retirement or preservation fund, the provident fund must be in a position to inform the transferee fund of the split of the fund interest between the value that remains subject to annuitisation and the value that continues to enjoy vested right protection.
Example: Provident fund member transfers to new fundÂ
Facts: 
Person S, a member of Investment Provident Fund, is 29 years old on 1 March 2015, at which time the fund interest is R1 000 000. Person S continues to contribute to the provident fund.
Six years later, Person S resigns. At this point, the R1 000 000 has grown to R2 000 000. The new contributions that Person S made to the Investment Provident Fund (and the growth thereon) amounts to R500 000. Person S transfers this R2 500 000 balance to a preservation fund. When Person S turns 70, Person S resigns from the preservation fund with a retirement interest of R10 000 000. The pre-1 March account of R2 000 000 grew to R8 500 000, and the subsequent amount of R500 000 grew to R1 500 000.
Administration
Investment Provident Fund must maintain an account for Person S in respect of the fund interest of R1 000 000 as at 1 March 2015 and any growth thereon (R1 000 000).
Investment Provident Fund must also maintain a separate account for any contributions made after 1 March 2015 and any growth thereon (totaling R500 000).
When Person S transfers these amounts to the preservation fund, Investment Provident Fund must provide the preservation fund with a split of fund interests with one account falling within annuitisation (R500 000) and the other enjoying vested right protection (R2 000 000).
Preservation fund
The preservation fund must keep separate accounts for Person S. One account must exist in respect of the fund interest of R2 000 000 that continues to enjoy vested right protection and any growth thereon (R6 500 000). A separate account is required for the R500 000 that remains subject to annuitisation and any growth thereon (R1 000 000).
Result 
The pre-1 March 2015 contributions plus growth thereon (that is, R8 500 000) will remain free from annuitisation. The newer amounts (of R1 500 000) will become subject to the new dispensation. Member W may only take one-third of the R1 500 000 as a lump sum while the remainder is subject to annuitisation.
De minimis exception
As a result of the amendment, the current threshold for the de minimis exception (R75 000) will be doubled to R150 000 for all retirement funds. As a result, every member may receive their entire retirement interest in the form of a lump sum as long as the portion of the member’s retirement interest that is possibly subject to mandatory annuitisation (that is, the two-thirds amount) does not exceed R150 000.
Example: De minimis exception
Facts:
Member T of Consolidated Provident Fund retires at 60 years of age. Member T was 48 years old on 1 March 2015, at which time Member T’s fund interest was R450 000, which increases to R600 000 upon Member T’s retirement.
Prior to retirement, Member T contributed R80 000 to Consolidated Provident Fund after 1 March 2015 with growth of R40 000. The final retirement interest was R720 000.
Result
The pre-1 March 2015 amount plus growth (that is, R600 000) thereon is free from annuitisation. The remaining (R120 000) amount is potentially subject to mandatory annuitisation but for the de minimis threshold (R150 000). Member T can accordingly receive the entire R720 000 in the form of a lump sum.
The transfer of retirement savings to provident and provident preservation funds from other funds will be exempt from tax.
Commentary
Following the amendment to the rules relating to tax deductible retirement fund contributions, effective 1 March 2014, it was inevitable that National Treasury would implement the compulsory annuitisation amendment. It is indeed fortunate that provident fund investments prior to 1 March 2015 and members over 55 on 1 March 2015 will be exempt from the amendment.
The knee-jerk reaction from many will be that they would rather move to privately held investments if they can no longer withdraw 100% of their provident fund benefits. This requires far more in-depth analysis.
Retirement funds remain the only legal means of creating a tax-deductible retirement plan. This must be coupled with the other benefits of retirement funds, including tax-free growth within the retirement fund and estate duty exemption in respect of death benefits paid by a retirement fund.
The tax-free lump sum schedules contained in the second schedule to the income tax act have been adjusted in Budget 2014.
The tax-free lump sum on retirement has been increased to R500 000. And a new 18% tax bracket installed to R700 000. The tax rates imposed on lump sum benefits above R700 000 are prohibitive, as high as 36%. Most taxpayers in retirement would achieve a lower marginal tax rate by electing to receive an annuity. The days of basing a retirement plan on a 100% withdrawal of benefits from a retirement fund were over before the amendment reached parliament.
In most instances the taxpayer will still enjoy tax-efficient lump sums on retirement by simply drawing down one-third of the accumulated retirement benefit. The modern tax-efficient retirement plan concentrates on retaining retirement capital within the tax haven of the retirement fund. Withdrawal benefits are limited through the use of the living annuity principle, to both contain tax exposure and allow the retirement capital to grow in a tax-free environment.
The living annuity principle is also far more tax-efficient when it comes to medical expenses incurred in retirement. Taxable income created by the annuity is offset against the medical rebate system. This principle cannot be achieved when pursuing the lump sum alternative.
Defined benefit pension funds have been phased out by many employers. This effectively leaves the choice for most taxpayers between provident funds and retirement annuity funds. The administrative costs of many provident funds exceed that of retirement annuity funds.
Pension and provident funds provided by employers have possibly become outdated as the modern career seldom spans 40 years with the same employer. Now that the tax deduction on contribution is the same, irrespective of fund choice, the responsible employee is in the position to build up a suite of retirement annuity investments without being dependent on the employer. This inherently makes almost inevitable career-changing decisions far easier.
In short, the amendment is not as horrific as it would seem. It simply follows the evolution of retirement planning from the pursuit of the lump sum principle to the active management of the living annuity principle.
Examples sourced from the explanatory memorandum to the 2013 Income Tax Act.
This article originally appeared in Provident funds and annuity alignments in glacier by Sanlam, The {Inside} Story
Transcription of the video:
MATTHEW LESTER: Hi there. I’m Matthew Lester at the Rhodes Business School. Some of you may have heard that there are moves afoot to change Provident Funds with effect from 1st March 2015 to bring them in line with other types of retirement funds. What’s going on here and is there a need to panic?
Let’s go back on the Employer/Employee relationship over the last 20 years. Twenty years ago, your Employer provided with your life, disability, and sickness benefits, your medical aid (generally on a 50/50 basis), and a Defined Benefit Pension Fund form which you would retire at about the age of 65.Â
Over the last 20 years, this has undergone substantial change as we have moved employment more or less to a basis of cost-to-company. You can have whatever benefits you like, but you are going to pay for them. This has substantially changed the way we look at Defined Benefit Pension Funds
In the past, we used to get a Defined Benefit Pension Fund, but now we’re going to a new basis because we’re saying to the Employee ‘you can have a Pension Fund, a Provident Fund, or you can provide for your own retirement in a Retirement Annuity Fund’. There are also Benefit Funds, which take over balances from the other three funds.Â
The basic concept is that if you have a Defined Benefit Pension Fund, you can only withdraw one-third of the actuarial value on retirement. However, if you have your own Provident Fund, it’s all yours. You can take 100 percent of the accumulated benefits and disappear. If you want to buy your family a coffee shop in George, well then good luck to you.
A Retirement Annuity Fund is similar to a Pension Fund in that you may only draw one-third of the accumulated benefit, and Benefit Funds, the character of whatever was put in there is retained. The big change that is happening is with Provident Funds from 1st March 2015. They are going to say the one-third commutation rule applies, i.e. you can only draw one-third in cash. The remainder has to buy you an annuity.Â
In implementing this new rule, there are a lot of softening provisions. They say ‘take a Provident Fund’. Firstly, if you are over 55 on 1st March 2015, you won’t be touched by this new amendment. You may still take the full 100 percent benefit – no annuitisation need be applied. Then there is a De Minimis rule, which says that if your Fund is less than one-hundred-and-fifty-thousand-Rand, you can still take the total capital, regardless.
However, if you are below 55 on 1st March 2015, then pay attention. It becomes a little bit complicated, because your benefits prior to 1st March 2015, plus the cumulated growth thereon, will be accounted for separately by the Fund Managers, and will remain untouched. You can still draw the total amount on retirement.
However, any benefits resulting after 1st March 2015, plus growth thereon: you will be required to annuitise two-thirds of the balance unless the balance is less than one-hundred-and-fifty-thousand-Rand. Then you can take the whole amount.  People joining a Fund after 1st March 2015 will be required to annuitise two-thirds of their Provident Fund.
‘Oh dear’ everybody cries, ‘just when we got to Budget 2014’. We see that the taxation on lump sum benefits has been eased a little bit. We can draw five-hundred-thousand-Rand tax-free in retirement and the first threshold, which is taxed at 18 percent, runs all the way up to seven-hundred-thousand’. The higher rates of up to 36 percent are then applied from R1.05m. People have always enjoyed these lump sums and now they think that the world has changed but actually, it’s been changed for some time. We just haven’t realised why.Â
We need to have a look at ‘withdraw benefits’ from all Retirement Funds and say the following: ‘when you look at a retirement fund, you are investing a tax-deductible contribution at up to 40 percent discount’. These contributions will be capped at a maximum of three-hundred-and-fifty-thousand or 27.5 percent of taxable income from the 2015/16 year of assessment.Â
However, once your money is in the Fund, it grows tax-free. All Retirement Funds have now become a tax haven and it goes even further in that no CGT or Estate Duty will be applied when you die.
When one looks at the claims made by SARS – that the average tax rate of South Africans has reduced from almost 35 percent in 1994 to about 18 percent today – one can get sceptical. One can say that we are taxed on a far wider range of fringe benefits. However, when it comes to pensioners, they don’t have fringe benefits, thus they have benefitted substantially from the widening of the tax brackets since 2000.Â
In the 2014/15 Budget, they widened the brackets even further, granting a further R9bn worth of relief, mainly at the lower end of the tax table. This is where you and most of are going to live – believe it or not – when we are in retirement. We’re going to pay a lot less tax.
When one looks at Retirement Fund withdrawal benefits, what we’re saying is this: ‘yes, take a lump sum on retirement of up to seven-hundred-thousand-Rand, because it makes absolute sense if the tax rate is below 18 percent’. However, then start thinking: using the Living Annuity principle, limit your withdrawals from a Retirement Fund to create taxable income that will utilise the lower tax brackets and rebates. Then draw a little bit more that will be covered by the new medical rebate, which is based on a 33 percent inherent tax rate, if you are over 65.
The remainder should remain within the sanctuary of the Retirement Fund and grow tax-free until it is needed. If anything’s left, those death benefits can be passed on to your beneficiaries outside of your estate, and exempt from your Estate Duty. That’s pretty neat, isn’t it?
If one takes this all into a computation and say ‘well, I’m going to need five-hundred-thousand-Rand per year for retirement’, the big problem is how to generate five-hundred-thousand-rand per year. Presuming that we can, if the five-hundred-thousand-Rand of income per year can be structured as follows: we say ‘take four-hundred-thousand-Rand out of your Retirement Annuity Fund, using the Living Annuity principle’.Â
You’ll also have some cash. Let’s say you have one million in cash: that will generate about fifty-thousand-Rands’ worth of interest. You might have some private investments, which would deal another fifty-thousand-Rand in capital gains, so that totals the five-hundred-thousand-Rand starting point.Â
However, the deductions for the retired pensioner are something else. Firstly, we get an Enhanced Interest Deduction (thirty-four-thousand-five-hundred-Rand worth of tax-free interest), and then another thirty-thousand-Rands’ worth of tax-free capital gain every year. The resultant accumulated capital gain – only 25 percent of it lands being taxable.
Then we get to Taxable Income and we work out the tax thereon, but there’s still good news to come because as a pensioner, you will get the primary rebate, then the age rebate, and then the new medical rebate on your medical expenditure. I’ve put in seventy-thousand-Rands’ worth of medical expenses per year, which for two people in retirement, is quite plausible.
All of this scenario boils down to an average tax rate of 12 percent on five-hundred-thousand-Rand and as we say in the classics, ‘that’s not too shabby, Nige’. So what’s changed? We’ve changed from an era where we used to look to take lump sums on retirement, to a new era where we want to take annuity income and control the flow of gross income to the pensioner. In that way, we can manage the tax rates down to a very acceptable level. This is a complete change from 20 years ago, and it actually is supported by the new view of ‘Provident Fund Benefits are going to have to be annuitised’.Â
So there you have it: Provident Fund alignment from next year is not going to have an adverse effect on many people. In fact, for some it might bring some relief.
I’m Matthew Lester at the Rhodes Business School. Thank you for your attention.
