The impact of the 2016 Budget Speech on retirement funds

By Kobus Hanekom, Simeka Consultants & Actuaries

In what was arguably the most important budget speech in the history of South Africa, Finance Minister Pravin Gordhan delivered a hard hitting speech outlining how the country could deliver itself out of its economic doldrums. Primarily, the Budget boiled down to the implementation of measures to show a credible path back to debt stabilisation. However, he also made a number of far-reaching proposals relevant to the retirement fund industry as a whole.

The good news for consumers is that the Minister was able to balance the Budget without increasing the maximum marginal tax rate or VAT. He has, however, increased the capital gains inclusion rate as well as transfer duty.

Overall, the government remains committed to its retirement reform objectives as announced in the 2014 budget update.

Arguably the most important provision in this Bill is the postponement of compulsory annuitisation upon retirement from provident funds to 1 March 2018.

1. Update on social security and retirement reforms

According to the Minister, Government has made significant progress in bringing about a fairer and more effective retirement system over the last 20 years. Government is committed to the release of the comprehensive social security reform paper later this year, led by the Ministers of Social Development and Finance.

Despite the postponement of annuitisation for provident funds, government remains committed to its retirement reform objectives as announced in the 2014 Budget update on retirement reforms paper, released on 14 March 2014. The National Treasury intends to publish the final default regulations later this year, after considering comments received from the public.

Key elements of the reforms include:

• Mandation or auto-enrollment
• Improving fund disclosures
• Getting defaults right
• Consolidating the number of funds
• Simplifying retirement savings products and enabling portability between providers
• Ensuring effective intermediation

Comment:  It is interesting to note that preservation is no longer listed as a key priority in contrast to 2015.

Tighter regulation of the retirement funding industry is part of this reform effort, with the specific focus on managing costs. The intention is to protect members’ interest and ensure that funds are not dissipated by unnecessary administration and financial costs, and that members’ income in retirement is assured. Treasury’s engagements in this regard with stakeholders will continue this year.

The National Health Insurance White Paper has been published, and proposals for comprehensive social security will be released by mid-year.

• Postponement of annuitisation requirements

The Revenue Laws Amendment Bill 2016 introduced to Parliament on 24 February 2016 gives effect to the decision by Cabinet last week to postpone the annuitisation requirement for provident fund members for two years to allow for further consultation with key stakeholders.

Changes to T-day and tax harmonisation:

The de minimis (minimum threshold) amount for lump sum retirement benefits will remain  R75 000 till 1 March 2018.

Although the Minister previously indicated that the revised R247 500 minimum threshold introduced in the Taxation Laws Amendment Act, 2015 would still apply from 1 March 2016, he has now altered his stance. The de minimus amount will remain unchanged at R75 000.  In an attempt to deal with union concerns, it was proposed late last year that if your retirement benefit did not exceed R247 500, you could take the entire amount in cash. This minimum threshold, effective 1 March 2016, has now been deleted in the Bill and has been replaced with a similar provision that will only apply from 1 March 2018. This means that the current de minimis of R75 000 will continue to apply till 1 March 2018.

As a result of an oversight, however, the position of paragraph (c) referring to pension funds has not been adjusted properly in the draft Bill and will have to be corrected.

• Allowable deduction for fringe benefit of employer contributions to defined benefit retirement funds

Section 11(k)(iii) of the Income Tax Act, 1962 (‘the Act’) inadvertently limited the allowable deduction for the fringe benefit of employer contributions to retirement funds to the actual value of the employer contribution. Clause 2 of the Revenue Laws Amendment Bill, 2016 however provides for a correction of the value of the fringe benefit in respect of employer contributions to defined benefit retirement funds that must be deemed to be the employee contribution. It makes provision for the deemed employee contribution to be equal to the value of the fringe benefit under paragraph 12D of the Seventh Schedule to the Act even if such value is greater than the actual contribution paid by the employer.

• Passive income deduction

Before 1 March 2016, taxpayers were able to deduct retirement annuity contributions against their passive or non-trading income up to a certain limit. The current wording of section 11(k) of the Act, which introduces the harmonised tax regime for retirement contributions from 1 March 2016, does not allow for contributions to any retirement fund to be set off against passive income. It is proposed that section 11(k) of the Act be amended to allow for retirement contributions to be deducted against passive income, subject to the available limits.

• Rollover of excess contributions prior to 1 March 2016

It is proposed that, in order to rectify an oversight, section 11(k) of the Act be amended to allow for the rollover of excess contributions to retirement annuity funds and pension funds accumulated up to 29 February 2016.

• Order of allowable deductions

To correct the ordering rule for calculating allowable deductions in the determination of taxable income, it is proposed that the allowable deduction under section 11(k) of the Act be determined before the allowable deduction under section 18A (donations).

• Valuation of contributions made to defined benefit retirement funds

Paragraph 12D of the Seventh Schedule of the Act only makes provision for contributions actually made by the employer or employee to certain retirement funds, and excludes contributions made on behalf of the employer or employee (for example, by the retirement fund). It is proposed that paragraph 12D of the Seventh Schedule be amended to include all contributions made for the member’s benefit. Other technical amendments to paragraph 12D include clarifying that retirement fund income is the full amount used to determine the employer’s contribution, not only remuneration as defined in paragraph 1 of the Fourth Schedule. A potential issue of double counting for retirement funds with a hybrid structure (having both defined benefit and defined contribution elements) will be removed. It will also be made clear when actuaries can provide an updated contribution certificate.

• Vested rights for provident fund members – divorce order settlements

From 1 March 2018, provident fund members may be required to purchase an annuity using a portion of contributions made after that date. However, all contributions made before 1 March 2018 will not be subject to annuitisation (generally referred to as vested rights). To allocate this vested right fairly in the case of a divorce, it is proposed that the withdrawal of retirement benefits arising from divorce order settlements be proportionally attributed as a reduction against both the vested right and non-vested right portions of the retirement fund savings.

• Vested rights for provident fund members – mandatory transfer

From 1 March 2018, provident fund members above the age of 55 will be able to continue contributing to that provident fund without being required to purchase an annuity upon retirement. However, if they transfer to another retirement fund, then any future contributions to that fund would not be exempt from annuitisation. It is proposed that forced transfers (through the closure of a retirement fund) will not affect the member’s ability to take contributions made from 1 March 2018 onwards as a lump sum. Further technical corrections are required to ensure that all contributions to provident funds or pension funds with lump sum benefits made before 1 March 2018 are included in the vested rights provisions, in line with the policy intent. Specifically, the vested rights provision inadvertently excluded transfers made to pension funds, as defined under paragraph (c) of the definition of ‘pension fund’ in section 1 of the Act, and to preservation provident funds.

• Foreign pension contributions, annuities and payouts

When the residence-based taxation system was introduced in 2001, section 10(1)(gC) was added to the Act to exempt foreign pensions derived from past employment in a foreign jurisdiction (i.e. from a source outside of South Africa). The question of how contributions to foreign pension funds and the taxation of payments from foreign funds should be dealt with raises a number of issues, which require a review.

2. Personal Income Tax

To reduce the impact of inflation on lower- and middle-income earners, Government proposes that the primary rebate and the bottom three income brackets be adjusted by 1.8% and 3.4% respectively.

Comment: The income brackets for those earning R550 101 and higher has not been increased to compensate for fiscal drag. The net effect is that those with higher incomes will pay more in tax.

Regrettably, the tax tables for retirement fund lump sum benefits have yet again not been adjusted to compensate for inflation this year.

• Capital gains tax

Government proposes to increase the inclusion rate for capital gains for individuals from 33.3% to 40%, and for companies from 66.6% to 80%. This will raise the maximum effective capital gains tax rate for individuals from 13.7% to 16.4%, and for companies from 18.6% to 22.4%. The annual amount above which capital gains become taxable for individuals will increase from R30 000 to R40 000. The effective rate applicable to trusts will increase from 27.3% to 32.8%. These new rates will become effective for years of assessment beginning on or after 1 March 2016.

• Medical scheme contributions

Government proposes to increase monthly medical scheme contribution tax credits in line with inflation, maintaining the current level of relief in real terms. These tax credits will be increased from R270 to R286 from 1 March 2016 for the first two beneficiaries, and from R181 to R192 for additional beneficiaries. This will cost the fiscus an estimated R1.1 billion.

• Demarcation of medical schemes

Government aims to publish final regulations early in 2016 to demarcate medical schemes and health insurance products. Parameters are proposed for health insurance products to preserve the principles of social solidarity and cross-subsidisation embedded in medical schemes.

• Social grants

Overeall expenditure on social assistance will increase from R129 billion this year to R165 billion in 2018/19.

The old age, disability and care dependency grants will increase by R80 to R1 500 in April 2016, and by a further R10 to R1 510 in October 2016. The child support grant will increase by R20 to R350 in April 2016 and the foster care grant will increase by R30 to R890 in April 2016.

3. National Health Insurance

According to Arthur Kamp, Economist at Sanlam Investments, the elephant in the room is National Health Insurance (NHI). In its current form, according to the NHI White Paper, published in December 2015, the funding plan is to use a mandatory prepayment system and to raise general taxes, although Minister Gordhan indicated the funding plan is still being considered.

For illustration, the NHI White Paper includes a projection showing total NHI spending at R256 billion (2010 prices) so that spending on healthcare by the public sector increases from around 4% of GDP currently to 6.2% of GDP in 2025/26, but only if the economy grows at 3.5% in real terms. This reflects a funding shortfall of R72 billion (2010 prices).

The Reserve Bank, however, argues that potential growth is currently below 2%. Of course, potential growth may lift, but should this not be the case the NHI White Paper includes projection, which indicates a R108 billion funding shortfall in 2025/26 (2010 prices) if the economy grows at just 2%. That would leave public sector spending on health at closer to 7% of GDP. That would be an especially onerous gap to fill. Clarity is needed on this issue. 

4. Financial markets:  can we avoid sub-investment grade status on our sovereign debt?

Finally, the real concern appears to be focused on South Africa’s growth potential, since the fiscal numbers do not add up if growth does not lift. Promising initiatives are under way to promote stronger long-term economic growth, including planned initiatives that encompass co-operation between government, business and labour. Although these are clearly welcome, it will take time for the results to show up.

The Budget makes it clear that getting growth going hinges on the success of the social contract between government, labour and business called upon by the Minister. Within this there is renewed scope for the private sector to partner with government in promoting investment and growth.

The Budget Review strongly emphasises the important role State Owned Enterprises (SOEs) have to play in creating an enabling environment for growth. It provides a sobering assessment of the financial condition of some SOEs (including reference to the ongoing insolvent position of the Road Accident Fund and the technical insolvency of SAA), pointing to declining profitability, poor governance and weak balance sheets. Further, the Budget opens the door for private sector participation in improving governance and allowing competition in sectors where SOEs have monopolies. Moreover, the Budget also highlighted the success of the Renewable Energy Independent Power Producer programme and announced the expansion of partnerships with the private sector to include electricity from coal (3126MW) and a gas-to-power programme. Importantly, the Presidential Review Commission recommendations on SOEs are to be implemented.

Ultimately, the debt stabilisation trajectory shown is a welcome development. As is, it should reduce the downgrade risk. But, that said, the risk of a further downgrade is not nil. Ultimately, the likely outcome of the ratings agencies’ decisions on this is unknowable. Only time will tell.

But at least financial markets have, to a significant extent, already priced in the possibility of a downgrade to sub-investment grade. Another mitigating factor is that most of the South African government’s debt is denominated in domestic currency, which carries a higher rating than for its foreign currency denominated debt, which amounts to a relatively low 10% of total government dept.

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