Preservation Funds Explained (Summary of RF1/98)

Preservation Funds aim to protect and preserve pension and provident fund benefits for members exiting approved retirement funds.

Proper retirement planning should form a very important part of each client's financial planning strategy. In order to cater for this very specific need, Momentum has launched the FundsAtWork Preservation Portfolio.

Preservation funds are specialised retirement planning vehicles and the South African Revenue Service (SARS) has set out special conditions with which they must comply. This article endeavours to explain SARS Practice Note RF 1/98 and any other pertinent questions clients may have.

Questions

What lump sum benefits may be transferred to a preservation fund?

Benefits may be transferred from any approved pension or provident fund on the member's resignation, retrenchment or dismissal from employment or on the winding up of the employer's fund (referred to in this article as the previous fund). Benefits may not be transferred into a preservation fund when the member retires. It must be emphasized that pension fund benefits may only be transferred to a preservation pension fund and similarly provident fund benefits may only be transferred to a preservation provident fund. If the member's employer is taken over by, or is merged with another company and the member is retrenched or dismissed or leaves service, then the benefits may normally be transferred to a preservation fund. However, if the member enters into a contract of employment with the new company and therefore becomes a member of the new employer's fund, then the benefit may not be transferred to a preservation fund.

What role does the member's previous employer play with regard to the preservation fund?

In addition to participating in an "employer fund" established for its employees, the employer must participate in the preservation fund the member wishes to join. This does not place any administrative responsibilities, financial burdens or legal liabilities on the employer. It is merely a requirement that the employer "participates" in the preservation fund prior to termination of the member's employment or winding up of the previous fund.

Is there a time period within which the member may join the preservation fund?

The member may join the preservation fund:

On their actual date of resignation, or retrenchment; or
On the date of winding up of the previous fund.

Can the member's benefit be transferred into more than one preservation fund?

No, the member may transfer the benefit to one preservation fund only, as splitting of the benefit is not permitted. However, if the member belonged to both a pension and provident fund, the pension benefit must be transferred into a preservation pension fund and the provident fund benefit into a preservation provident fund.

What portion of the benefit can be transferred to a preservation fund?

A transfer to a preservation fund will not be possible in circumstances where the benefit to be transferred has been reduced. Briefly what this means is, that the member cannot receive a portion of the withdrawal benefit, including the R1 800 tax-free portion, and transfer the balance to a preservation fund. The member must either take the full amount on withdrawal or transfer the full amount to the preservation fund.

Are there any exceptions to the rule stated above?

Yes, and these are:

A deduction in terms of Section 37D of the Pension Funds Act. These deductions are:
- Amounts owed by an employee in respect of housing loans or housing guarantees.
- Damages caused to the employer as a result of fraud, theft, dishonesty or misconduct of the employee. The employee must admit liability in writing or the employer must have obtained a court judgment against the member.
- With a member's consent, medical aid subscriptions and insurance premiums.
- Such other deductions as the Registrar of Pension Funds may agree to.
A transfer of a portion of the benefit to a retirement annuity fund.
The payment of a portion of the member's benefit to a spouse in terms of section 7(8) of the Divorce Act.

However, a deduction in terms of Section 37D of the Pension Funds Act, or a claim in terms of the Divorce Act will be treated as the first and final withdrawal from the preservation fund. No further withdrawals from the preservation fund will be allowed.

Can the member transfer part of the benefit to a preservation fund and part to a retirement annuity fund?

Yes, as long as the rules of the employer's fund allow it.

Can the member contribute to the preservation fund?

No, a preservation fund may not receive additional contributions and may only receive direct payments from other approved retirement funds. However, any future qualifying benefits may also be preserved in the preservation fund.

Can a member withdraw money from the preservation fund?

The member may withdraw either a portion of or the entire benefit from the preservation fund at any time (except as per point 6 above). However, only one withdrawal or partial withdrawal may be taken from the preservation fund prior to retirement. If the member chose to preserve a portion of the original withdrawal or winding up benefit in a retirement annuity fund and transferred the balance to a preservation fund he/she will still be entitled to the one withdrawal from the preservation fund.

Can the member transfer the benefits from one preservation fund to another preservation fund?

If the member changes jobs and the new employer "participates" in a preservation fund, the member may transfer his/her benefits to that fund. As mentioned above, pension preservation benefits may only be transferred to a preservation pension fund and provident preservation benefits to a preservation provident fund. If the member has already taken the one withdrawal from the preservation fund, they will not be allowed any further withdrawal from the new preservation fund.

Can a member transfer benefits from a preservation fund to another fund other than a preservation fund?

If the member becomes a member of the new employer's pension or provident fund he / she may transfer his / her preservation fund benefits to that fund. The transfer is permissible regardless of whether the member had taken a withdrawal benefit from the preservation fund in the past. The full benefit (less tax if the transfer occurs from a preservation pension fund to a provident fund) must be paid into the new fund and will be subject to the rules of the new fund.

No transfer is allowed from a preservation fund to a retirement annuity fund.

What are the conditions on retirement from the preservation fund?

When the member retires from employment he/she must retire from the preservation fund at the same time. However, if the member is not employed, he/she may retire from the preservation fund at any time between the ages of 55 and 70.

If the member retires from the current employer as a result of disability before reaching the age of 55, he/she may also retire from the preservation fund.

If the member is not employed and becomes permanently disabled, he/she may retire from the preservation fund before the age 55, if the preservation fund trustees are satisfied that the member is permanently disabled.

How are the benefits taxed on transfer to a preservation fund?

The transfer of benefits from a pension fund to a preservation pension fund and from a provident fund to a preservation provident fund will not attract tax (paragraph 6 of the Second schedule to the Income Tax Act).

How are my benefits taxed on withdrawal from the preservation fund?

A benefit taken from the preservation fund will be taxed as a lump sum withdrawal benefit, in terms of the Second Schedule to the Income Tax Act.

How are the years of service in the previous fund treated if the member transfers the benefits to the preservation fund?

The years of service that the member accumulated in the previous fund before transferring to the preservation fund are used in the calculation of the tax-free lump sum benefit on death or retirement and will be retained in the preservation fund. The years of membership do not increase while in the preservation fund.

Another important point to be noted is that the value of 'N' (number of years of service) for the purposes of calculation of the tax-free portion in terms of formula A of the Second Schedule to the Income Tax Act will be reduced proportionally in respect of:

deductions in terms of Section 37D of the Pension Funds Act; or
a deduction in terms of the Divorce Act; or
a transfer to a retirement annuity fund.

What are the main differences between a preservation fund and a retirement annuity fund?

The member cannot take a cash withdrawal benefit from a retirement annuity fund prior to retirement. Please note as well that if the member had reduced his/her benefit for reasons other than in 6 above, he/she may not transfer to a preservation fund. However, there is no such restriction enforced with regard to a retirement annuity fund.

Other important issues to consider are:
If the member belongs to a retirement annuity fund, he/she can elect to retire at any stage between the ages of 55 and 69. Whereas, in a preservation fund, if the member is in employment, he/she will have to retire from the preservation fund at the same time as he/she retires from the employer fund. This makes efficient tax planning very difficult.
The lump sum payment from the preservation fund and the employer fund is subject to limitations imposed by formula A of the Second Schedule to the Income Tax Act. This implies that unless the member has 20 years of service, after the 'N' factor has been reduced as discussed in 15 above, the member will not qualify for the full R120 000 tax concession from the retirement fund.
The choice of a preservation fund or a retirement annuity will depend on:

the possible need for cash prior to retirement;
the tax-free portions allowed at retirement by each of the funds;
the member's personal and tax planning requirements.

Can members transfer their benefits from a public sector retirement fund to a preservation fund?

Addendum B to RF1/98 confirms that the term "approved" within the context of RF1/98 includes funds that are recognised as public sector retirement funds (also often referred to as State funds). In theory, therefore, a member of a public sector fund will be allowed to transfer his/her benefits to a preservation fund.

Does the previous fund have authority to restrict the member from withdrawing from the preservation fund?

Yes, but in terms of the Pensions Funds Adjudicator's determinations, restrictions are only enforceable if the previous fund has the authority to do so in terms of its rules, and the preservation fund rules also allow such a restriction. Therefore, if the rules of the previous fund are silent, the member may withdraw from the preservation fund, subject to item 6.

Who manages the preservation funds?

A board of trustees manages the FundsAtWork Preservation Portfolio.

What are the duties of the board of trustees?

In addition to the trustees' normal duties, they must also ensure that the rules of the preservation fund comply with SARS practice note RF 1/98 and the addendum to the practice note. Trustees must also ensure that measures are in place to detect whether reductions (other than the reductions mentioned in 6 above) have taken place and reject transfers of benefits, which have been so reduced.

What commission is payable on preservation funds?

With effect from 2 January 1999 the maximum commission payable for preservation funds increased from 2,5% plus VAT to 3% plus VAT of the amount transferred.

For application forms and any further information on the FundsAtWork Preservation Portfolio, please contact our Client Contact Centre on 0860 65 75 85 or CLICK HERE to download the relevant form.