Changes to tax treatment of retirement fund contributions from 1 March 2015
05 March 2014
Posted by: Author: Dan Foster
Author: Dan Foster (Webber Wentzel)
The Taxation Laws Amendment Act No 31 of 2013 has made several changes to the income tax legislation impacting retirement funds. These rules were first mooted over three years ago, and the amendments were originally slated to come into effect from 1 March 2014, but have been postponed. Unless further proposals or postponements are announced in the budget speech on 26 February, the changes will come into effect from 1 March 2015 (the 2015-16 tax year).
Current Rules - A summary
- Employer contributions to pension and provident funds are tax-free fringe benefits.
- Employer contributions to Retirement Annuity Funds (RAFs) are a taxable fringe benefit.
- The employer's corporate income tax deduction for retirement contributions is limited to 20% of total employee remuneration, in terms of South African Revenue Service (SARS) practice.
Employee / Individual contributions:
- Employee contributions to pension funds are deductible up to 7.5% of pensionable earnings (retirement funding income or RFI).
- Employee or individual contributions to RAFs are deductible up to 15% of non-pensionable earnings ( non-retirement funding income or non-RFI).
- Employee contributions to provident funds are non-deductible.
At least two thirds of a pension fund or RAF must be taken as an annuity, with the lump sum capped at one third. In contrast, 100% of a provident fund may be paid as a lump sum on withdrawal.
New rules - A summary
From 1 March 2015, the new system will treat all employer- paid contributions to pension, provident and retirement annuity funds as a deductible employment expense for the employer and a taxable fringe benefit in the hands of the employee.
These taxable employer-paid contributions will, however, be deemed to have been made by the employee for personal income tax deduction purposes, who shall in turn be eligible for a tax deduction for such contributions to approved funds, in addition to any contributions made by themselves to any of the three fund types. The new system creates an overall tax deduction to the individual taxpayer for all contributions to retirement funds, neutralising the fringe benefits tax up to a prescribed cap. New limits to the tax-deductible contribution are introduced, as follows:
- The limitation is now calculated with reference to "taxable income" or "remuneration (whichever is greater), as defined, rather than RFI and non-RFI.
- The individual's tax deduction, in respect of aggregated employer and personal contributions, shall be limited to 27.5% of taxable income or remuneration (whichever is greater). This is higher than the current combined contribution limit of 22.5% (i.e. 15% (RAF) plus 7.5% (pension)), which importantly now includes provident fund contributions, and employer-contributions to approved life insurance (which was previously taxable, but not included in the retirement funding limits).
- An overall monetary cap of R350 000 per annum limits the available deduction, regardless of the taxpayer's age. This limitation will impact taxpayers with taxable income in excess of ZAR1.272 730.00 per annum, however disallowed contributions can be carried forward for deduction in a subsequent year of assessment (subject to the same limits). Contributions which are never deducted shall reduce the taxable proceeds on withdrawal/retirement, as is currently the case.
Other noteworthy changes
- A special formula will apply to determine the taxable value of employer-funded retirement benefits in the case of a defined benefit fund (as opposed to a defined contribution fund, where the contribution is the taxable/deductible amount).
- An employer's corporate income tax deduction for contributions to retirement funds will be unlimited. A partnership is deemed to be the employer of the relevant partners for the purposes of this deduction.
- Premiums paid by individuals to so-called income protection insurance policies in respect of death, disablement, severe injury or unemployment will cease to be tax deductible from 1 March 2015, and employer-paid premiums to such policies will also become taxable fringe benefits (perks). The proceeds of such policies upon the happening of an insured event will, however, be exempt from tax, whether paid as a lump sum or an annuity. This exemption will apply to the entire proceeds after 1 March 2015, even to the extent that premiums were previously deductible (ie there will be no claw-back provisions but rather a clean break).
- Also proposed from 1 March 2015 is the alignment of the annuitisation rules for all three fund types, so that only one-third of an individual's fund may be withdrawn as a lump sum, with the taxpayer being obligated to purchase an annuity with the remaining two-thirds. It is further proposed that this new annuitisation rule shall not apply to the balance of provident funds as at 1 March 2015 - such balance shall be subject to the old rules (ie grandfathering).
- The ability to withdraw funds prior to retirement, for example upon ceasing to be a provident fund member when changing employment, is also proposed to be curtailed.
What does this mean to you?
Although employer contributions will become a taxable benefit, such contributions are deemed to be made by the employee, and are deductible (subject to the caps), regardless of the type of fund (ie including employee contributions to provident funds). This means that employer contributions will be effectively tax-free, provided the aggregate employee and employer contributions are within the new limitations.
Individuals earning under ZAR1 272 730 per annum will be able to make higher tax-free contributions to pension, provident and retirement annuity funds, from 1 March 2015, either personally or as employer-contributions (ie as part of their package). This is because the combined cap has been increased to 27.5%. The intention of government is to simplify and encourage such long-term savings.
Individuals earning over ZAR1 272 730 per annum will, however, be subject to the monetary cap of ZAR350 000 in deductible contributions per annum. Although excess contributions will carry forward and be deductible in future years of assessment or upon retirement, it may certainly discourage fund contributions in excess of the monetary limitation. Government has indicated that they do not wish for the fiscus to fund tax relief for retirement savings beyond this limit.
Individuals earning only exempt income, such as dividends, will be unable to make use of the deduction, as the cap is calculated based on the higher of remuneration or taxable income.
The changes are certain to cause a restructuring of retirement savings and remuneration packages by individuals and employers, and activity in the retirement fund arena.
The abolition of the deduction for income protection policy premiums is also likely to cause a re-think of such policies, notwithstanding that the proceeds will become tax-free (which may in turn reduce the amount insured and consequently the premiums). There will certainly be an impact on insurers offering and paying-out such policies, and on the beneficiaries of these policies. Employers offering this as a fringe benefit to employees will also need to consider the tax implications.
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This article first appeared on webberwentzel.com.