How provident fund annuitisation changes affect approved lump-sum disability benefits

New tax rules on the annuitisation of provident funds and lump-sum payouts made at retirement took effect on March 1, 2021.

Fund members should be aware of additional implications for approved lump-sum disability benefits.

On retirement, members of these funds who were under age 55 on this date (known as T-day) may still take amounts which accrued prior to March 1 2021, plus the fund return, in cash. Members over age 55 on T-day will have access to all amounts in the fund in cash when retiring from that fund. This is referred to as ‘vested benefits’ as opposed to ‘non-vested benefits’ where annuitisation rules apply to amounts above R247 500.

Approved lump-sum disability benefits paid by a pension fund

The approved (provided by the fund) lump-sum disability benefit in a pension fund was previously included as part of the fund benefit. It was normally treated in its totality as an ill-health early retirement benefit from the fund. The cash amount was limited to a maximum of one-third of the benefit, while the balance was used to buy a pension.

Approved lump-sum disability benefits from provident funds

Those under the age of 55 will have the same limitations on their lump-sum disability benefit and how this is treated in terms of annuitisation as applies to pension funds.

• Members over age 55 on March 1, 2021

The lump-sum disability benefit will be part of the vested benefits in the provident fund of which the member had membership on T-day. This means that the member can receive this payment in cash, after tax.

But if the member transfers to a new fund after T-day, and is then disabled, any lump-sum disability benefit paid out of the new fund will be a non-vested benefit. This means that annuitisation rules will now apply.

• Lump-sum disability benefits under 55

Only amounts which have accrued before T-day fall into vested benefits. If a member is disabled after T-day, the lump-sum disability benefit payable will not fall into the vested benefits. The payment will be treated as a non-vested benefit. This means that the annuitisation rules, where the total benefit exceeds R247 500, will now apply to the lump-sum disability benefit.

Reform

While the above may be an unintended consequence of the annuitisation rules, we should take a step back and reconsider the real intention of reform.

Various stakeholders in the industry introduced and agreed upon reform as it became evident that current regulations were failing the member. Almost 50% of members retire on less than one-third of their final average salary, which renders a large part of people poor and dependent on the state. This is unsustainable and needs to change.

Reform has brought in different forms of laws to increase the savings culture and provide certain incentives – like a tax deduction if a member saves more, up to a certain limit. 

With the lump-sum disability benefit now subject to annuitisation, funds need to consider this question: Would an income structured benefit still meet the intention and expectations by members, the fund and the employer in terms of their incapacity procedure? 

The trustees and employer will have to revisit why the approved lump-sum disability benefit was selected in the first place.

Was this to ensure that there would be a lump sum to:

• Meet the cost of additional care or adjustments to the home to assist the disabled employee, or
• Provide cash support ultimately to members who are found to be totally and permanently disabled?

If the above intent of providing a lump-sum benefit still stands, the trustees and the employer may need to consider changing the tax status of this benefit from approved to unapproved. This will ensure that the initial intention and expectations are still met.

Caution is made that changing to an unapproved benefit would mean that the employee would need to pay fringe benefit tax on the monthly premium. However, the benefit would be paid as a tax-free lump sum separate from the retirement fund for total and permanent disablement.

These discussions must therefore include decision makers on the employer side to:

• Help facilitate the messaging to the employees,
• Manage any payroll impacts, and
• Align with their incapacity procedures.

Any benefit structure implemented must be well considered to best suit the needs of the members. This could enhance the financial well-being of employees and lead to the best retirement outcomes.

Dolana Conco is regional executive at Alexander Forbes Retirement Consulting.