Insurance companies are offering members of pension funds to move their retirement capital from their retirement fund into an ‘untied’ annuity – i.e. an annuity offered by an insurance company to the applicant who will be the owner of the insurance policy issued in respect of this annuity. Insurance companies are relying on a circular and an unofficial ‘memorandum’ once issued by Namfisa on this topic, both of which in our opinion are ambiguous. They have also approached Inland Revenue who issued a ruling to them in this context. All three communications that were issued make it clear that the capital must retain the protection it would enjoy under the Pension Funds Act. We believe this mechanism does not afford such protection. The consequence of our opinion is that the member who used this mechanism may be taxed at any time in future should Inland Revenue conclude that the capital that was moved to an ‘untied’ annuity should have been taxed, with interest being raised on top of it.
For the fund such outcome could at best present a significant reputational risk, potentially even a pecuniary risk. A further risk for the member is the potential demise of the insurance company that could mean the loss of the member’s entire retirement capital. Again, for the fund such outcome could at best present a significant reputational risk but potentially even a pecuniary risk.
Unfortunately we earn much scorn as the ‘odd one out’ and are at times even discredited by brokers who ‘smell’ the hidden agenda of the Benchmark Retirement Fund offering a pension arrangement to members upon retirement from another fund which is fully compliant with both the Income Tax Act and the Pension Funds Act. This mechanism is referred to a ‘tied’ annuity – i.e. an annuity offered by an approved retirement fund to its members.
We consider it our obligation to assess the potential implications of the payment of a benefit for the beneficiary and the fund from a legal point of view. Where we are of the opinion that such payment presents a risk to either the fund or the member, or both, we would not affect payment without having pointed out the possible consequences to the member and/ or the fund. As fund administrator, we cannot be expected to assume responsibility for such risk and will not allow the member to be exposed to this risk. Where the fund is prepared to assume liability for the risk we will proceed as directed by the fund.
The law unfortunately is not always clear and has to be interpreted if no reliance can be placed on a legal precedent, as is mostly the case. Interpreting laws is a matter of opinion, sometimes well qualified, but at times also unqualified. Even if such interpretation is given by the best legal expert it will only be proven right or wrong once a court has pronounced itself on such a matter. A fund struggling with this matter is well advised to distinguish between qualified and unqualified advice when confronted with different opinions.
While the uncertainty prevails on the matter of ‘tied’ versus ‘untied’ annuities, the procedure we have instituted transfers the tax risk to Inland Revenue by requesting a tax directive with a form which clearly spells out that the retirement fund member intends to move the retirement capital to such an ‘untied’ annuity. After all correspondence with Inland Revenue, Inland Revenue will find it very difficult to ever argue that RFS has not clearly communicated its opinion and the substance of such transactions.
As far the risk of the demise of the underwriting insurance company is concerned, RFS similarly has repeatedly pointed out its opinion to Namfisa and has expressed its concern to Namfisa on the two communications Namfisa issued in this context, that are being interpreted by insurance companies to justify such transactions. RFS clients have of course also been made aware via circulars and the Benchtest newsletters of the risks presented by the mechanism of providing ‘untied’ annuities with retirement capital from a retirement fund.
In the past pension funds were a popular avenue for member’s obtaining funding for the purchase or expansion or alteration of their dwelling. Recently the Pension Funds Act was amended as referred to in Benchtest 09.2014. This amendment read together with the Income Tax Act, presents a significant risk to funds that do still offer loans or loan guarantees to its members, of not being able to recover the full outstanding amount from a member’s benefit.
Unfortunately, banks who still finance loans secured by a pension fund guarantee, and who were approached to assist their pension fund clients in mitigating the risk created by our laws and referred to in the first paragraph, simply refused to affect any changes to their contracts and documentation for this purpose.
As the result funds are reconsidering their involvement in affording members access to financing for housing loans and many will no doubt phase out housing loans as a benefit for members. We foresee that pension funds will no longer offer housing loan benefits in the medium term and funds are in fact well advised not to grant housing loans any longer.
One may ask, why does the Pension Funds Act create an avenue for members accessing their benefits for housing purposes while this would result in funds shouldering a significant risk of being unable to recover an outstanding housing loan balance?
This is a much discussed shortcoming of remuneration structures nowadays. It is important that employers understand the implication of this for their retirement fund members and that they consider their position carefully. Staff generally do not understand or appreciate the implicit goals of their retirement fund while they are young, healthy and mobile, job-wise, and often only realise their folly when it is too late! This is where the employer has to take a more paternalistic, long term view to ascertain that the short-term view of staff does not prevail, to their own detriment. We all know of course that employees have a tendency to point a finger at others when they realise their own follies.
We suggest the principle should be that the guaranteed package is used as the basis for determining your member’s provident fund contribution, rather than basic salary or wage. The typical retirement fund structure, as it evolved over the past 100 years, which may be referred to as the ‘norm in the market’, aims to provide members with a reasonable income replacement in the event of death, disablement and eventual retirement. The ‘norm in the market’ for retirement, broadly speaking, is about 2% of final income, times years of service and requires a total contribution accumulation of around 15% of income, while employed. To this contribution accumulation towards retirement has to be added the cost of death and disability as well as fund management. We suggest the ‘norm in the market’ for a total contribution rate is between 10% and 11% by employer and around 7% by employee.
Strictly speaking, the ‘norm in the market’ should be set at 100% of remuneration package. In the case of an employer whose total fund contribution rate exceeds the above ‘norm in the market’, this norm of 100% can be tempered due to the above average contribution rate towards the fund, that in itself should secure benefits above the ‘norm in the market’, presumably at the expense of employees’ take home pay. If your total fund contribution rate for example totals 20%, which is above the ‘norm in the market’ alluded to above of around 17%, we would suggest that the desired minimum contribution rate should be set at 85% of remuneration package, to still achieve the implicit goals of retirement funds.
This is an important topic that trustees should discuss with their employers and their fund consultant.
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