Budget 2015 shone a light on a RA tax loop hole

Some aspects of the 2015 Budget put fear into some hearts. One point in particular remains in flux and we wait to see which way legislation will go. In 2008, the maximum age at which you could contribute to a retirement annuity was removed; and at the same time retirement fund benefits were excluded from the dutiable estate. This meant that you could contribute to an RA as much and for as long as you like and when you pass on, the money goes to the 37C beneficiaries tax free. The minister has noticed this tax loop hole and has plans to close it up. Denver Keswell, senior legal advisor with Nedgroup Investments, tells us why this is a problem and what may happen in the future. – Candice Paine

This is a special podcast brought to you by Nedgroup Investments and today we’re chatting to Denver Keswell.  He’s a Senior Legal Advisor at Nedgroup Investments.  Denver, Budget 2015 referred to various changes, which will affect retirement planning opportunities for individuals.  Notably, RAs have had the spotlight shone on them and the role they play in estate planning.  Can you tell us a little bit more around how our RAs have been used in the past and what the changes are, going forward?

Thanks, Candice.  Yes, with RAs over the last decade, there have been various changes in terms of legislation around Retirement Annuities that have made it extremely tax effective.  Because of these changes, you’ll see that clients and financial planners have used Retirement Annuities largely from a tax perspective for tax planning and not just as a retirement vehicle, which is traditionally how it is used.  I’d say in the last decade, the three biggest issues around these changes was (1) if you are invested in a Retirement Annuity or any Retirement Fund for that matter, you are exempt from Estate Duty.  What I mean by that is that if you were sitting in Unit Trusts, Endowment, or even a bank account; on your death, that asset would be dutiable.  Potentially, 20 percent of that asset would go to SARS.  That was one of the big changes and if you are sitting in an approved Retirement Fund, you are not liable for Estate Duty.  That asset is completely exempt.  2.  The other thing that happened was that the upper age limit was actually removed.  What I mean by that is that if you go to age 70, you were not allowed to contribute towards a Retirement Annuity.  You could not enter and therefore, you had to purchase your Compulsory Annuity at that stage.  That upper age limit was also removed.

Even if you didn’t require the income at that stage, you would have to start withdrawing from the annuity.

Correct.  At that stage, you would have to retire and you would have to purchase a compulsory annuity at that stage.  That was also removed in the last decade. Whilst you’re within the Fund – when you’ve contributed towards a Retirement Fund – you used to actually pay tax at a rate of 18 percent.  That was reduced to nine percent and currently, you don’t pay any tax whilst you’re within the Fund.  For those three reasons, Retirement Annuities became very popular; not just for retirement reasons, but also for tax planning.  Now, what this also enabled clients to do was that they could actually contribute a massive lump sum (hypothetically, R10m) into a Retirement Annuity.  On death, that benefit would go to a Section 37C beneficiary.  What would then happen is that a beneficiary (assuming it’s a daughter) would decide to take the lump sum.  They would then be able to take that lump sum and that lump sum would not be subject to Estate Duty.  Automatically, the client has already save himself up to 20 percent of Estate Duty.

Is this primarily used by nigh net worth individuals who are looking at large amounts of Estate Duty or would people who were below the R3.5 rebate doing this as well?

The intention wasn’t that only high net worth individuals would use it, obviously.  It’s a legitimate retirement savings product, but the loophole was that created was that high net worth individuals could then use it to obviously reduce their tax exposure.  In that scenario (of the R10m investment), they would automatically save up to R2m that would otherwise have to go to SARS if they were in another type of investment vehicle.  There was no Estate Duty, but there was income tax so that lump sum would still be subject to income tax.  How do you calculate income tax on Retirement Funds?  Basically, it’s R500, 000.00 currently tax-free plus your previously disallowed contributions.  If you contribute the R10m into a single contribution/Retirement Annuity…if you think about it, the majority of that R10m would not qualify for a tax deduction.  It would be a very small portion that would really qualify for a tax deduction.  Ultimately, the beneficiary would receive that without that benefit being subject to Estate Duty and their tax-free portion on it would be R500, 000.00 plus the majority of that R10m so let’s just call it R10m.  Essentially, if the member invested R10m and died within a year, the growth was another R1m, sitting at R11m; the beneficiary could potentially inherit that benefit without having any Estate Duty and basically, R10.5m would be free from income tax.  A very small portion of that R11m would be subject to income tax.

Okay, so clearly, our Government’s not very happy with that and they want to close the loophole.  What are they proposing, going forward?

Absolutely.  If you looked at Budget this year in Annexure C, which deals with the Additional Tax Amendments, it’s very early days but you could see where the direction is going.  They’ve recognised that this is a loophole that wasn’t really intended and is being unfairly used.  What they’re proposing is that the portion that we spoke about – that you didn’t get a deduction on (our example of the R10m and the majority of it that you wouldn’t get a tax deduction on); they’re proposing that the non-deductible portion should be dutiable in terms of Estate Duty.  In our example, if you didn’t get tax deduction in our example of R9.5…fair enough.  You get the amount in.  Income tax would work the same way.  You’d get the advantages.  It’s taxed in the deceased’s name but from a Duty perspective, they are proposing that the R9.5m in our example (that you didn’t get a tax deduction on), should form part of your dutiable estate.  Think about it.  If you use a Retirement Annuity legitimately, in the sense that you’re contributing, you’re calculating your tax-free deduction on that amount (15 percent of net Fund Retirement funded income), and all your contributions qualifies as a tax deduction then it’s not going to be an issue.  Essentially, the lump sum that’s taken out is not going to be dutiable.

What happens to people whom, in good faith, have been contribution to an RA over and above the amounts that were deductible, if the legislation changes?  I understand that they might bring back the age at which you are able to contribute up until, as well.

That’s a really good question and that’s the hot debate at the moment.  Obviously, when we saw this, a lot of the role players in the industry have commented on this.  Obviously, we think that it would be completely unfair if you now say that we introduce legislation and it has to apply retrospectively.  Those that have legitimately used their Retirement Annuity for retirement as well as tax reasons (remember, this was perfectly acceptable and in terms of the legislation), it would be unfair for those who have contributed to now say ‘listen, if you have contributed in the past and there was a portion that didn’t qualify for a tax deduction, that that portion should be dutiable’.  Obviously, we’d like for any legislation that would be introduced, not to apply retrospectively.

Okay.  In terms of the proposal, what kind of timeline are we looking at, should the legislation actually change?

Unfortunately, at this stage we don’t really have any indication.  You’ll see it in Annexure C.  There are not timelines around it.  At this stage, all I can see is that it’s an idea.  It’s a direction that Treasury intends going in.  It could be in the next year.   It could be in the next five years.  At this stage, we really don’t have any indication.

So at the moment, everyone is just scrutinising the legislation and we basically need to watch this space.  Is that what you’re saying, Denver?

Absolutely.  Going forward, those that do market this to potential clients should make them aware of this.  Whilst Retirement Annuities are still (from a tax perspective) absolutely fantastic to invest in, I just think that members/clients should be aware that down the line, there may potentially be an impact on any portion that they contribute, which doesn’t qualify as a tax deduction from an Estate Duty perspective.

Thanks so much for your insights today, Denver.  It’s been great chatting to you.

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