Published in IRF.INITY, 1 June 2015
By Giselle Gould, Business Development Director, Fairheads Benefit Services
In terms of section 37C of the Pension Funds Act, the trustees of retirement funds have four options when deciding how to allocate benefits due to minor dependants/nominees who have lost a breadwinner. They can pay a lump sum benefit to the guardian; retain and administer the monies in the retirement fund; pay the funds to a trust (if a trust has been nominated by the member or guardian); or pay them to a beneficiary fund, which is the pension fund vehicle government introduced in 2009 to safely house the assets of minor dependents.
There is a false perception in the industry that the Pension Funds Adjudicator is not in favour of beneficiary funds. However there have only been a relatively few instances in which the decision to place monies in beneficiary funds has been set aside. On the other hand, the question of whether due process has been followed by trustees in arriving at their decision has always been an issue.
The entire area of death claims is complex and wide-ranging and beneficiary funds remain relatively new, but I believe there are a few additional issues that have been overlooked:
Broader industry reform
Lump sum payments for children do not sit easily with the broader pension reform currently being undertaken, especially the adoption of the annuitisation principle for all retirement benefits and the general move away from lump sum payments.
If government and the regulator are of the view that retiree should not receive lump sums at retirement, then I believe that it would be imprudent to pay children’s benefits as lump sums.
This situation has been cogently argued in an article published in Insurance & Tax in December 2014 by Naleen Jeram, a senior legal advisor at Momentum Employee Benefits and Adjunct Professor at UCT Law Faculty, in which he calls inter alia for simplification of the section 37C process.
Why should children bear the risk of lump sum payments?
It also seems unreasonable to expect children to bear the risk of lump sum payments to their guardian as they have no power to determine how the guardian spends the money. The current test applied by law and followed by the PFA is that if the guardian is “competent”, based on an investigation into their educational status, financial literacy and ability in practice to manage their own financial affairs, then trustees should pay the child’s death benefit to the guardian.
But sadly financial competency is no guarantee that the guardian would use the funds in the best interests of the child. Mr Jeram states in the same article:
“This legal test is based on the premise/assumption that financial competency leads to monies being utilized in the interest of minors. However, one may have a guardian who is very well qualified in finances and financial planning and has a very good track record of handling monies, but does that really mean he/she will use the monies in the best interests of the minor children?”
As a guide to help trustees in their decision of where to place a lump sum I would suggest they ask the following questions:
- Will the money be used in the best interests of the child?
- Will the money be stretched as far as possible to ensure the child gets the best education available?
- Can the money practically be ring fenced if the guardian dies?
- Can the guardian access the expertise required to achieve the best returns, at a reasonable cost?
The truth is that beneficiary funds meet all the above criteria. After all, government set up these funds expressly for the purpose of protecting and managing minors’ assets on an annuity principle.
Once the lump sum has been paid into a beneficiary fund, the guardian receives a monthly amount to use for supporting the child and can request capital amounts to be paid for school fees and similar maintenance related expenses.
Not enough known about the benefits
I believe trustees are not yet sufficiently aware of the advantages of beneficiary funds. They are cost effective and tax effective, and offer institutional investment returns. They are taxed in the same manner as pension funds in South Africa, that is no tax is paid in the fund. Furthermore any payment out of a beneficiary fund, whether capital or income, is tax free.
Although some beneficiary fund accounts run into millions of rands, the average size is around R100 000 which, if carefully managed, can provide a monthly income and finance a child’s entire education through to tertiary level. When the member turns 18, the account is terminated and the funds paid out unless the member requests they remain in the beneficiary fund
A practical example
The graph illustrates an example of a member, aged five years at inception, with an original capital investment of R100 000. The funds are invested according to the beneficiary fund board approved asset allocation model and payments from the fund include:
- Regular income payments to the guardian until the child reaches the age of majority
- Annual capital payments for education related expenses
- All fund costs
- A final termination benefit of approximately R115 000 payable in a lump sum to the member upon reaching the age of majority.
The example illustrates how a relatively small investment of R100 000 can be stretched over a period of 13 years to provide for the education and well-being of the minor child, as well as preserving capital for a lump sum payout on termination. .
I doubt there are many guardians who could achieve that on their own. Even if they used investment experts, there are investment fees to consider as well as the tax implications.
Note: The above example is based on Fairheads Umbrella Beneficiary Fund approved asset allocation model which is reblended annually. Historical investment returns have been used to project future investment returns (money market 12 month performance, income fund 36 month performance, stable funds 36 month erformance and balanced fund 60 months performance). The example includes annual capital payments equivalent to 5% of capital introduced, income payments of 5% of capital introduced (paid monthly) as well as all fees and charge
See Fairheads Times, Issue 31, June 2015 for this article and others