Last week, the focus of this column was on the almost hysterical reaction of many financial advisers to a Financial Services Board requirement that they write examinations to prove that they are sufficiently knowledgeable about financial services regulations, which mainly centre on the Financial Advisory and Intermediary Services (FAIS) Act.
The legislation sets out the obligations and responsibilities of your financial adviser, as well as your obligations and responsibilities, to ensure that you receive appropriate advice and are provided with products that are suitable for your financial needs.
It is quite clear from the various determinations by the Ombud for Financial Services Providers that many advisers do not know what they should about the FAIS Act, let alone the other legislation.
It is also the experience of Personal Finance that the gaps in advisers’ knowledge extend to other issues, including financial products.
As I said in this column last week, there are many very good financial advisers who are knowledgeable and well qualified, and who act in your best interests.
The point is that all advisers should be able to meet the same professional standards. The problem is that all of them do not, and you have no idea which ones are good and which ones are bad. The intention of the examinations is to set minimum standards of knowledge.
Below are three examples of where incomplete or poor information provided by advisers can harm you.
Example 1
“I thought what you wrote was the biggest load of crap,” a financial adviser told me when I recently queried why he had told a client that what I had written about the taxation of retirement savings was wrong.
Among other things, I said in a column following this year’s Budget: “Note: it is important to name dependants or beneficiaries to assist (retirement) fund trustees in the distribution of your accumulated retirement benefits if you die before retirement. After retirement, where there is a capital residue, you decide, without interference, who gets the money on your death.”
The adviser objected to the second sentence, which refers to what happens after retirement. He says that in all cases the fund trustees decide who will inherit money from an annuity.
The adviser is wrong. The vast majority of investment-linked living annuities (illas) are bought by individuals in their own name using savings in an occupational retirement fund or a retirement annuity (RA). In this case, what I wrote applies: it is for the individual to decide what happens to any capital left at death.
However, there is an anomaly in that some (very few) occupational retirement funds buy illas for their members in the name of the fund and not in the names of the individual members. In this case, the fund trustees decide what will happen to the residue of the capital on death. The trustees will have to take into account the dependants of the illa annuitant, as well as any nominated beneficiaries who may not be dependent on the annuitant.
Knowledge of what happens to an illa at death is important, because it affects your adviser’s ability to provide proper advice about estate planning.
One of the reasons many people buy illas (or annuities that are guaranteed to continue paying a predetermined amount for a fixed number of years whether you are alive or dead, and for the rest of your life if you survive the guarantee period) is that they want to leave money to their heirs in a tax-efficient way.
When an illa annuitant, who has the right to choose who will receive any residual capital, dies, the nominated heirs can decide how to receive the money on the annuitant’s death, namely:
* As a lump sum, which will be taxed in the hands of your estate, subject to any estate duty and capital gains tax (CGT) exemptions at death.
* As an income for life. Because an illa is a retirement product, it will not be subject to CGT and the investment build-up will not be subject to income tax. However, the heir will pay tax at his or her marginal rate of income tax.
* Under old legislation a beneficiary could choose to receive an accelerated annuity over five years. This choice is no longer available. However Peter Stephan, the senior policy adviser at the Association for Savings & Investment SA (Asisa), who has confirmed all this information, says representations have been made to the authorities to allow beneficiaries the additional choice of a combination of a lump sum and an annuity income.
Example 2
Last week, I was called by a financial adviser who wanted me to tell him about the tax consequences of retrenchment packages. I would have thought that this was basic knowledge, particularly as the information is freely available on websites such as that of the National Treasury.
Granted, the matter is complex, but surely with more than one million people losing their jobs in the recent recession, it is knowledge that all advisers should have at their fingertips – otherwise how can they provide proper advice on things such as preserving retirement savings and emergency funds?
This is how it works:
The most important thing about retirement savings is that you receive tax incentives on pension funds, including RAs, to save.
At retirement, you have access to all of your retirement savings as a cash lump sum if you are a member of a provident fund and to one-third of your savings as a lump sum if you are a member of a pension fund, including an RA (you must buy a pension for life with the other two-thirds).
The first R315 000 of the lump sum, plus any contributions that you were not permitted to deduct against your taxable income, is tax-free. The next R315 000 is taxed at 18 percent. The next R315 000 is taxed at 27 percent. Amounts over R945 001 are taxed at 36 percent.
The amounts you receive from all funds are cumulative. Any retirement benefit taken as a cash lump sum from October 2007 and any early (pre-retirement) withdrawal from your savings taken as a cash lump sum after March 1, 2009 will be added to the cumulative total.
So if you take a lump sum of, say, R630 001 from your occupational fund, you will pay tax of R56 700. But if, four years later, you mature an RA from which you take a lump sum of R200 000, it will be taxed at 27 percent.
If you resign from your job and withdraw all your savings from an occupational retirement fund, the first R22 500 is tax-free. Any amount between R22 501 and R600 000 is taxed at 18 percent. The next R300 000 is taxed at 27 percent. Any amount over R900 000 is |taxed at 36 percent.
Again, the amounts are cumulative, and include any other withdrawal benefits taken from March 2009 and any retirement benefits taken from October 2007.
Things are more complex if you are retrenched. And it is important that you, your employer and your financial adviser get it right.
Peter Stephan, the senior policy strategist at the Association for Savings & Investment SA, says any cash lump sum you withdraw from your retirement fund will be taxed in accordance with the R315 000 table if:
* Your services are terminated prior to your normal retirement age due to your employer having ceased to carry on, or intending to cease carrying on, the trade in respect of which you are employed or appointed; or
* You have become redundant because of your employer having effected a general reduction in personnel or a reduction in personnel of a particular class.
After the age of 55, for tax purposes, depending on the rules of your fund, you can decide to take early retirement rather than resign, in which case your lump sum will be taxed according to the retirement table (R315 000 tax-free) and not the resignation table (R22 500 tax-free). It does not matter if you get a new job the next day.
As of this tax year, from March 1 any severance package is included in the lump sum calculations, adding to the cumulative amount.
For example, if you are aged 30 and are retrenched today, and your retrenchment package is made up of a severance package of R100 000 and your occupational retirement savings of R1 million, making a total benefit of R1 100 000.
If you decide to take R600 000 as a cash lump sum and preserve the balance for retirement, the tax will be R51 300 (the tax on R600 000 on the retirement table is R51 300).
In 30 years’ time, you retire and take another R600 000 as a lump sum. It will then be considered that you have taken R1.2 million as a lump sum. So on the second R600 000 you will also pay tax according to the retirement table, which will be R233 550 less R51 300, which equals R182 250 (18 percent on the next R30 000, 27 percent on the next R315 000 and 36 percent on the balance).
Example 3
A few years ago, when Personal Finance exposed the mis-selling of high-cost, poor-benefit RA policies flogged by the life assurance industry, we informed you, our readers, that you were not obliged to sign contracts for life assurance RAs in terms of which you had to pay premiums until the age of 55 (and often beyond). In fact, if you take out a life assurance RA, you should limit your contractual contribution period to the minimum.
The reason is that it is not a legal requirement to contribute to the age of 55. Product floggers were claiming that you are required to do so, but in fact the Income Tax Act states only that you cannot withdraw any money saved in an RA until the age of 55.
The reason for selling you a contract that kept you paying until the age of 55 and beyond was that the longer the term of the RA contract, the more your adviser received in commission.
They did not give a hoot about you, particularly because if you failed to maintain your contributions, the life companies would slug you with a confiscatory penalty that could see a sizeable portion, or even all, of your savings disappear. The confiscatory penalty is applied even if you are unable to maintain your payments because you have lost your job.
The life companies and their product floggers still insist on selling these nasty little products, although the government has reined them in somewhat on the confiscatory penalties. But you can still have 30 percent of your savings confiscated on products sold before January 1, 2009 and 15 percent on products sold since that date.