T-Day Strategies for Umbrella Funds

By Dirk Oosthuizen, Executive Consultant, Simeka Consultants and Actuaries

Quarter 2: 2014

An aspect that may not have received much attention to date is, what responsibilities does T-Day place on a participating employer in an umbrella fund and the members of the joint forum or local board.

The key issues for consideration are:

• the management of PHI benefits and other fringe benefit payroll adjustments;
• the communication of annuitisation rules of provident funds at retirement;
• consolidation of hybrid funds;
• the adjustment of the contribution formulas to align with the tax deductibility formulas;
• amendment of the rules to allow members to make additional contributions;
• review the risk benefit (group death and disability) formulas accordingly;
• adopt a pension projection ratio (PPR) approach to guide and support members;
• using the opportunity to adjust the benefit structure and implement default contribution rates, preservation, investment and annuitisation strategies; and
• the communication of the tax and other changes to members.

Most umbrella sponsors will take the initiative to recommend to the trustees to consolidate hybrid funds with effect from T-Day.

Hybrid funds were designed to capitalise on the higher contribution deduction advantages of pension funds and the lump sum retirement benefit advantages of provident funds.

The members, therefore, made contributions to a pension fund and the employer made contributions to a provident fund. With the integration of provident funds into the pension fund annuitisation rules, these advantages will fall away and it thus makes sense to consolidate these funds.

Employers are encouraged to find ways of aligning their contribution formulas with the new tax deduction formulas. Exposing members to too many different formulas will make member communication and understanding more difficult to achieve. This can be done by adjusting the pensionable salary (PEAR) to be equal to remuneration or total guaranteed package (TGP); or by ensuring that the projected pension calculators put them in perspective. If PEAR is adjusted the contribution rates in the special rules may have to be amended.

One would like to think that umbrella funds will amend its general rules to allow members to make additional contributions and take advantage of the very generous tax deductions (if the rules do not already allow for this). If not, a participating employer will have to ask for an appropriate amendment to its special rules and investment regulations.

The employer should take this opportunity to review and request the trustees to adjust the group risk benefit formulas as well. Members often do not realise that their benefits are based on PEAR and not on TGP and are then shocked and disappointed when their benefits are lower than they anticipated. Risk PEAR is best structured as 100% of TGP.

To help ensure good retirement outcomes members are offered tools to assess the pensions they will be able to afford in retirement. A net replacement ratio (NRR) calculator typically calculates the pension expressed as a percentage of PEAR. We, however, prefer a pension projection ratio (PPR) calculation. It calculates the projected pension as a percentage of TGP net of contributions. This is much more accurate and useful for members as it is based on the amount that members actually have available to spend.

Premiums paid towards income disability insurance (PHI) will no longer be tax deductible from T-Day onwards. Members will have to be prepared for the cash flow implications.

Default benefits is a relatively new concept. Most sponsors offer default investment portfolios, but not that many offer a default contribution rate, a default preservation offering or a default annuitisation strategy. In the last two years defaults became increasingly important for National Treasury and currently it constitutes one of their top priorities. We expect a discussion paper on default benefits to be published in May this year. Current indications are that funds will be compelled to offer default benefits in future. Appropriate defaults can be of great value to the members and trustees, and service providers should be encouraged to take action as soon as possible.

The sponsor should do a standard communication to members on the tax changes associated with T-Day. Any amendments to the contribution formulas and benefit structures of the employer will typically have to be communicated to the members by the participating employer.