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In his second instalment following the news that President Jacob Zuma has signed into law new tax incentives, Matthew Lester asks himself if it’s worth having a Provident Fund anymore. He says for years many advisors said you couldn’t beat them, but now it’s time to re-evaluate that golden rule. Interesting reading. – Stuart Lowman
By Matthew Lester*
For years many advisors have said ‘you can’t beat a provident fund!’ But now that compulsory preservation has finally arrived with effect from 1 March 2016 it is high time to re-evaluate the golden rule.
There’s some history to the story.
A long time ago in a galaxy far away (actually about 30 years ago in South Africa) most employers provided compulsory defined benefit pension funds. The concept was ‘work for an employer for 30 plus years and you will get a handsome life pension annuity.’ In short, if you behaved yourself, retirement planning was the employer’s problem.
But then the marvels that the medical profession made us all live far longer than we were ever designed to go. So the actuaries (that clever lot who make accountants look normal) told employers that their defined benefit pension fund surpluses would quickly erode and employers would never be able to make good the promise of a carefree retirement for their exhausted employees.
So between circa 1980 and 2005 many employers convinced their employees to switch from defined benefit pension funds to defined benefit provident funds.
How did they do it?
‘If you die, the entire accumulated benefit will go to your family if you are on a provident fund. If you are on a pension fund your spouse will get a miserable pension and your kids will get v$koll” was the first promise.
‘When you retire from a provident fund you can cash in the whole lot. If you are on defined benefit pension fund or retirement annuity fund you can only cash in one-third of the accumulated fund. You will be a millionaire!’ They continued.
‘And the tax on lump sums is far less than the tax on annuities’, etc etc.’
So most employees fell for it and switched from defined benefit pension funds to defined contribution provident funds. New employees were generally not given the option of a defined benefit pension fund.
So employers successfully outsourced the responsibility of providing for retirement to the employee. That point seemed to fly right past the employee’s left ear and hit Jupiter.
Now bring the story back to RSA today.
The major class of employees remaining on defined benefit pension funds are civil servants. And those civil servants who make it to 60 with 30 plus years of service will tell you that they are sitting pretty. Provided they don’t retire or resign before 60, in which case a dreadful penalty applies. Early retirement for civil servants, like failure, is not an option. What a depressing prospect for a teacher.
The provident fund was often sold on the basis of the accumulated benefit would be paid to the members salary in cash on death. But more and more we hear ‘ But I’m not dead yet! And my provident fund benefits are exhausted. V$k the family, what about me?’.
During the 1990’s those who mastered the taxation computations associated with retirement from provident funds could score fantastic tax savings on lump sums paid by provident funds. But those loopholes are long since shut. And taxation on lump sums from provident funds over R700 000 is an expensive option.
If provident funds were the panacea to all ills we wouldn’t have so many pensioners in trouble today. Freedom of choice hasn’t done it for us.
But the important point is that few employers could ever afford to go back to defined benefit pension funds. It’s a non-starter.
Now that there is to be a level playing field between retirement funds the debate has to move on to:
- Is a provident fund as good as a retirement annuity?
- Do I want a retirement fund at all?
* Rhodes University Professor Matthew Lester was educated at St Johns College, Wits and Rhodes universities. He is a chartered accountant who has worked at Deloittes, SARS and BDO Spencer Steward. A member of the Davis Tax Committee investigating the structure of aspects of the RSA tax system, he is based in Grahamstown.