Employer Action Code: Act
The government has confirmed that implementation of compulsory annuitization of a portion of employees' provident fund balances at retirement takes effect on March 1, 2021. Currently, provident fund balances are “protected” benefits, meaning that members may elect at retirement to take up to their full balance as a cash lump sum and the remainder as an annuity. In practice, members tend to take full lump sums. In contrast, pension fund balances are “restricted” benefits, meaning that up to one-third may be taken as a cash lump sum at retirement and the remainder must be taken as an annuity. An annuity in the context of South African retirement funds can be a traditional life annuity guaranteed by an insurer or a “living annuity” (i.e., a series of drawdowns of the account balance with investment and demographic risk borne by the participant). Among companies surveyed by Willis Towers Watson with defined contribution plans, approximately a third allow participants to draw down their accounts as an annuity within the plan.
Tax legislation approved in 2015 aligned the tax treatment of contributions to approved retirement plans (both pension and provident funds) and allowed restricted balances below a de minimis amount (R247,500) to be paid as a cash lump sum on retirement. The legislation also intended to change the treatment of provident fund balances to being restricted benefits on retirement (with phased implementation), but lobbying by unions delayed implementation until this year.
It is important to note that there is no compulsory preservation before retirement (i.e., an employee who leaves employment at any time before retirement may choose to take the full balance as a cash lump sum, less tax), and there are no current proposals to change this. This applies to both pension and provident funds.
Key details
For members of provident funds (and provident preservation funds) as of March 1, 2021:
- Protected benefits (i.e., they continue to be payable fully as a lump sum on retirement) include:
- The member’s provident fund balance on March 1, 2021, plus investment returns up to retirement
- For members age 55 and above on March 1, 2021, contributions made after this date to the provident fund of which the person was a member on March 1, 2021, plus returns up to retirement, and any insured lump-sum disability benefit (provided under the rules of the provident fund of which the person was a member on March 1, 2021)
- Restricted benefits (i.e., up to one-third payable as a lump sum and the remainder as an annuity) include:
- For members age 55 and above on March 1, 2021, contributions made after March 1, 2021, to any fund other than the provident fund of which the person was a member on March 1, 2021, plus returns up to retirement
- For members under age 55 on March 1, 2021, contributions made after March 1, 2021, to any fund plus returns up to retirement, and any insured lump sum disability benefit (provided under the fund rules)
The treatment of pension fund benefits remains unchanged, although transfers of protected/restricted benefits between retirement funds must retain their respective protected/restricted status. The de minimis exception for restricted benefits continues to apply.
Employer implications
In most cases it will be some years before provident fund members feel any significant impact from this change, due to it applying only to prospective provident fund accumulations, other grandfathering provisions and the existing exception from annuitization requirements for de minimis retirement fund balances; however, administrators of provident and pension funds will need to maintain records of protected benefits applying to members with effect from March 1, 2021. In addition, a few provident funds provide members with insured lump-sum disability benefits, provided as a benefit of the fund. The premiums are paid out of contributions while benefits received (if any) are part of the claimant’s early retirement benefit; however, any such claims after March 1, 2021, for members under age 55 on that date would likely be subject to the annuitization requirement. Employers with such an arrangement may want to consider changing the plan so that benefit is funded independently of the fund — but because that would also change the tax treatment of plan premiums and benefits, any change needs to be assessed carefully. Employers offering hybrid plans (with employee contributions invested in a pension fund and employer contributions with the provident fund) may want to consider merging the components to reduce cost and complexity. Effective March 1, 2021, a pension-to-provident transfer will apparently be possible without tax implications, and this is the preferred basis for merging the components to ensure the maximum protected benefits of members age 55 or older on March 1, 2021.
