South Africa’s retirement funding industry is highly regulated, complex, and challenging to navigate independently. Knowing the differences between retirement fund vehicles and their tax implications is crucial for building a well-structured portfolio aligned with your needs.
In this article, we take a closer look at these vehicles, their benefits, and the legislation that governs them.
Retirement fund
In South Africa, all retirement funds are regulated by the Pension Funds Act, though they differ in structure and purpose. Broadly, a “retirement fund” includes pension funds, provident funds, preservation funds, and retirement annuities. Investments in these funds are strictly legislated, often referred to as “compulsory” savings. Pension and provident funds are typically occupational, while retirement annuities cater to individual investors. Despite these distinctions, all retirement funds are overseen by a board of trustees and operate according to their specific set of rules, ensuring compliance and governance across the industry.
Pension fund
A pension fund is a retirement fund set up by an employer for the investment of employees’ retirement fund savings. Each pension fund has its own set of rules, so it is important for investors to have insight into these rules. Both employers and employees may contribute towards the pension fund, while the government provides tax relief on these contributions in the form of rebates or deductions in the tax payable. At retirement, a member can make a maximum one-third withdrawal from the pension fund, subject to tax, and the remaining two-thirds must be used to purchase a life or living annuity to provide a post-retirement income.
Provident fund
Being a type of occupational retirement fund, provident funds are typically established by employers for their employees. Historically, provident funds allowed members to withdraw their full savings as a lump sum upon retirement. However, post-March 2021 reforms introduced annuitisation requirements, mandating part of the savings be used for a retirement income. This change aligns provident funds more closely with pension funds, promoting long-term financial security.
Preservation fund
Preservation funds are specifically designed to invest the proceeds of pension or provident funds in the event of dismissal, retrenchment or resignation with a view to preserving investments and tax benefits. Legislation permits investors to make one partial or full cash withdrawal from their preservation fund at any time before retirement. At retirement, investors can take a maximum one-third cash withdrawal, while the balance must be used to purchase an annuity.
Retirement annuity
Retirement annuities are ideal for those who are self-employed, do not contribute to a workplace fund, run their own business, or earn irregular income. As in the case of pension and provident funds, retirement annuities are tax efficient as they allow investors to invest up to 27.5% of their taxable income (less any amount that is being contributed towards a pension or provident fund) on a tax-free basis, up to a maximum of R350 000 per year. Modern retirement annuities allow investors to adjust monthly contributions, take a contribution holiday, and restart contributions at any stage without fear of penalties being charged. At retirement, one-third of the funds in an RA may be withdrawn in cash while the balance must be used to purchase a pension income.
Section 14 transfer
Retirement annuity (RA) investors are permitted to transfer their RA to another retirement annuity fund without paying any tax, with this process taking place in terms of Section 14 of the Pension Funds Act. Before deciding to move to an insurance-based retirement annuity, it is important to establish whether any penalties will be payable. Insurers generally incur upfront costs on RA policies, which they recover over the life of the contract. As such, early termination may result in a penalty being charged.
Two-pot retirement system
South Africa’s two-pot retirement system, introduced in March 2024, is designed to balance short-term financial access with long-term retirement savings. It divides retirement contributions into a savings pot and a retirement pot. The savings pot allows limited annual withdrawals to address immediate financial needs that may arise, while the retirement pot is preserved for retirement. There is also a vested pot that houses all contributions made up until 29 February 2024, plus fund returns and any other credit amounts.
Lump sum withdrawals
Over and above the annual withdrawal from the savings pot, there are two lump-sum benefits payable from a retirement fund. The withdrawal benefit is the benefit paid to a member before normal retirement age through resignation, withdrawal, or divorce. There is also the retirement benefit that is payable on a member’s death, retrenchment, or retirement. When a member of a retirement fund retires, they are entitled to make a lump sum withdrawal from the fund, which is subject to tax as per the withdrawal and retirement tax tables in the Second Schedule of the Income Tax Act.
Clean Break Principle
The Clean Break Principle in South Africa applies to divorce settlements involving retirement savings. It allows for the immediate division of a member’s retirement fund upon divorce, enabling the non-member spouse to access their entitled share (also known as ‘pension interest’) without waiting until the member retires. Introduced to promote fairness, this principle ensures financial independence post-divorce. The non-member has the option of transferring their share of the pension interest to another retirement fund or withdrawing it as a lump sum, subject to tax.
Paid up RA
Old-style insurance retirement annuities were essentially insurance policies that provided very little flexibility for investors. Unlike unit trust retirement annuities, where a policyholder stops contributing towards an insurance-based RA, the insurer will deem the policy to be ‘paid up’ and may charge an early termination penalty.
Beneficiary nomination
Section 37C of the Pension Fund Act governs the distribution and payment of lump sum payments on the death of a retirement fund member. Even though you have made beneficiary nominations on your retirement fund, keep in mind that it remains the function of the trustees to allocate and apportion these funds in the event of your passing. It is the trustees’ job to determine who your financial dependants are, with the aim being to ensure that no dependants are left without financial support. When identifying beneficiaries, the trustees will consider those people whom the deceased had a legal obligation to maintain, spouses, permanent life partners, stepchildren, adopted children, and even unborn children.
Umbrella fund
As opposed to a standalone retirement fund set up by a single employer, an umbrella fund is a retirement fund that multiple smaller employers can participate in. Generally, an umbrella fund is set up by a large financial institution so that smaller employers can benefit from the economies of scale offered by the umbrella fund. With an umbrella fund, the average cost per member is generally more cost-effective, and members can benefit from higher after-fee returns. Once formed, the founding institution will arrange for professional trustees, source an administrator, and implement group life and other services for the fund.
Section 37 transfer
It is not possible to transfer a life (or guaranteed) annuity to a living annuity, as the former is an insurance policy, whereas the latter is an investment-linked annuity. However, in terms of Section 37 of the Pension Funds Act, investors are able to transfer a living annuity from one platform to another, keeping in mind that this process can take a number of months to complete.
Grandfathered status
Prior to April 2011, assets were managed in accordance with Regulation 28 at the fund level, which meant that individual retirement fund members were not required to comply with Regulation 28 provided that the collective fund was in compliance. Since April 2011, all new retirement investments are required to adhere to the provisions of Regulation 28 at the individual level, while all individual members who invested prior to this date are exempt, provided that no transactional changes are made to the portfolio.
These pre-April 2011 investments retain what is referred to as ‘grandfathered’ status and do not need to be Regulation 28 compliant. However, should a member make any changes to their debit order, make ad hoc contributions, or perform any switches in the portfolio, the ‘grandfathered’ status will fall away, and the individual will need to make their investment Regulation 28 compliant.
Article by Craig Torr – Crue Invest (Pty) Ltd