Issue: December 2006/ January 2007
Liberty Life


This article on retirement funds is sponsored by Liberty Life to inform trustees in the public interest. Liberty Life does not endeavour to promote, through the content, its own products or services.

A trust creates a special fiduciary relationship which places stringent duties and liabilities on the trustees to prevent possible abuse of the confidence placed in them. It is important that the trustees have extensive knowledge of these duties and liabilities, as well as the Acts that have a bearing on trusts.

In this article we will answer some questions that might be of interest to trustees.

What is a pension fund and a provident fund?

The intention of both a pension and a provident fund is to provide financial security during retirement. The joint contributions of the employer and the employees are invested to build up benefits payable on retirement.

On retirement one third of the benefit from a pension fund may be taken in cash and the remaining two thirds must be used to buy a pension to provide a regular income for life. In the case of a provident fund the full benefit can be taken as a cash lump sum.

What is a defined benefit plan?

A defined benefit plan is the only retirement plan that gives employees a guaranteed retirement benefit based on remuneration and years of service.The employee knows what to expect on retirement, which makes retirement planning considerably easier.

What is a defined benefit plan?

In the case of a defined contribution pension fund (also known as a money purchase scheme) the contributions made to the fund are set down, or defined, in your employment contract and by the rules of the fund.

The employer guarantees to make a contribution to the retirement fund, but does not guarantee you a pension or what the pension will be. If the investments from your retirement fund savings perform poorly, you carry the loss. If they perform well, you benefit.

What are inclusive and exclusive funds?

An inclusive fund is a defined contribution fund where the administration fees and costs of insured benefits are deducted from contributions and not charged separately. As death and disability costs increase with age, the portion of the contribution available to fund retirement benefits therefore reduces.

In an exclusive fund, on the other hand, the administration fees and costs of insured benefits are separate from the portion available for investment (i.e. not deducted from contributions) and the entire contribution is allocated towards retirement benefits.

What is an umbrella fund?

An umbrella pension or provident fund is a single fund, usually established and managed by a life insurer, to which any employer or group of employers can apply for membership as a participating employer.

One advantage of an umbrella fund is that the employer joins a fund which is already registered and approved and has an established board of trustees. The legal requirements necessary for the implementation, registration and approval of a fund are therefore obviated. No rules need to be drawn up for each employer as there already exists a master set of rules which governs all participating employers. Variations applicable to each participating employer, known as “special rules”, may be included.

A major advantage is that umbrella funds give small employers the benefits of big funds, such as higher medical free limits and lower administration fees.

What is a preservation fund?

A preservation fund is an independent retirement fund to which a member’s paid-up benefits can be transferred on resignation, redundancy or dismissal from an employer. It preserves the member’s benefit for retirement. The member is allowed one withdrawal from the fund before retirement.

To gain entry to a preservation fund, the employer must apply (if not already a participating employer) to become a participating member of either a preservation pension fund (in the case of a pension fund) or preservation provident fund (in the case of a provident fund) prior to the member leaving the fund.

The withdrawing member must also apply prior to termination of employment to become a member of the preservation fund and to transfer benefits to the preservation fund on termination of employment.

What is the difference between approved and unapproved funds?

In terms of section 4 of the Pension Funds Act all funds have to be registered with the Registrar of Pension Funds. A fund is not allowed to carry on the business of a retirement fund without registration.

Approval by the South African Revenue Service is optional. However, an unapproved fund enjoys no tax concessions.

The South African Revenue Service approve a fund under the following circumstances:

• Pension Fund

If the Commissioner is satisfied that the fund is a permanent fund, bona fide established to provide annuities to employees on retirement (or to their dependants on their death) and that the fund rules have been complied with, the fund will be approved.

In order to continue as an approved fund, the rules of the fund must provide that:

  • contributions will be made in accordance with a specified scale
  • membership of the fund is a condition of employment for all eligible employees
  • existing employees can apply to become members within 12 months of the establishment of the fund
  • a maximum of one third of the total benefit may be commuted to cash on retirement
  • the employer cannot control the management or assets of the fund or derive any monetary gain from it
  • a benefit payable to a dependant of a member shall not be commuted later than six months after the member’s death

• Provident Fund

The same circumstances apply as for a pension fund except that approval will be withdrawn if the South African Revenue Service is not satisfied that the fund is a permanent bona fide fund established solely for providing benefits to employees on retirement, or to their dependants on their death.

Approval is not a once-off application, but applies on an annual basis.

What is an exempt and a non-exempt fund?

In the changes made to the Regulations to the Pension Funds Act, the previous distinction between underwritten and privately administered retirement funds became obsolete.

  1. Underwritten funds were fully insured funds which were administered by life insurers. These funds now qualify as:
    • Non-exempt funds: The fund may be exclusively invested in policies of insurance but may be administered by an institution other than a life insurer. Fully non-exempt funds must appoint a valuator who must perform an evaluation every three years, and an auditor must be appointed to check the books of the fund; or
    • Audit exempt funds. The fund is exclusively invested in policies of insurance, life insurers undertake all administration and the benefits are paid by life insurers; or
    • Valuation exempt funds. The benefits payable by the fund are either fully secured by the life insurer or are linked to the investment fund in such a way that the fund’s liabilities cannot exceed its assets; or
    • Both audit and valuation exempt funds. The administering life insurer of these only have to prepare an annual income-and-expenditure account and a statement of investments at both book and fair value. Every three years, and whenever the rules are changed, an actuarial certificate stating that the fund is valuation exempt, must be produced.

  2. Privately administered funds can now qualify as:
    • Non-exempt funds. These are subject to both audit and valuation requirements, or
    • Valuation exempt funds, as discussed above.

Note: Privately administered funds cannot qualify as audit exempt funds.

What is retirement funding income?

The remuneration which is taken into account in order to determine the contributions by a member or an employer to a pension or provident fund is regarded as retirement funding income.

Who is eligible to join a retirement fund?

The trustees or employer in consultation with the employees have to formulate who is eligible to join the fund. This must be decided in such a way as to comply with the requirements for approval of pension and provident funds contained in the Income Tax Act. The South African Revenue Service will not approve the rules of the fund if the classes of eligible employees are not laid down in the rules of the fund.The South African Revenue Service will not approve rules which allow entry at the full discretion of the employer. An employer must consult the employees before entrenching any eligibility conditions. Once trustees are appointed, they may formulate eligibility conditions, and may even amend any conditions imposed by the employer prior to the Pension Funds Amendment Act.

Some of the criteria for eligibility are:

  • Status (e.g. monthly paid employees, weekly paid employees or executives only).
  • Length of service (e.g. staff who have been employed for at least six months).
  • Salary limit (e.g. staff who earn over R15 000 per month).

Important is that once an employee complies with the eligibility criteria, membership of the fund is compulsory.

Can employees refuse to join a fund?
  1. Where a new fund is established, all existing employees who are eligible for membership must decide within 12 months of inception of the fund whether or not they wish to become members. Should they decide not to become members after this period, they are permanently ineligible to become members of this specific fund unless a special concession is received from the South African Revenue Service.
  2. Where an employee becomes employed by an employer who already has a fund and is eligible to join, he or she may not refuse to become a member as it is a condition of employment.
Can temporary staff or part-time employees be members of a fund?

The law does not exclude these employees but they normally don’t join funds because of the high turnover in employment and the resultant high costs involved.

Fund administrators used to restrict membership to permanent full-time employees, although this situation is changing as part-time employees increasingly demand similar benefits to those available to full-time staff. The Labour Relations Act does not distinguish between full-time and part-time employees and as such both should be treated equally.

As far as directors are concerned, it is a practice of the South African Revenue Service that only full-time working directors can join a fund.

Can members withdraw from the fund without leaving the company?

Eligible members who have joined a fund cannot withdraw or retire from the fund unless they leave the service of the employer.

What are the minimum and maximum permitted retirement ages?

Neither the Income Tax Act nor the Pension Funds Act stipulates any age requirements. However, in terms of the Second Schedule to the Income Tax Act, the lump sum benefits payable on retirement from a provident fund, other than on the grounds of ill health prior to the age of 55 in the case of males and 50 in the case of females, will be taxed as a withdrawal benefit and not as a retirement benefit. (The minimum retirement age of females was raised to age 55 on 1 March 2000 to eliminate gender discrimination).

These ages are thus practical minimum retirement age limitations for provident funds.

What happens if the business is sold or liquidated?

Neither of these has an impact on the fund because the fund is a separate legal entity.

The fund can be taken over by the new owners, continue on a paid-up basis (if the employer ceases to employ the members) or be terminated. When the business is sold, the fund can continue on its own under the new owners or it can be amalgamated with the fund of the new employer.