8 May 2020 by and Tax & Exchange Control Alert

Proposed expanded access to living annuity funds: A liquidity measure in response to COVID-19

The Explanatory Memorandum on the Disaster Management Tax Relief Bill, 2020 (Revised Draft) (Revised EM)) states that “the COVID-19 outbreak will have significant and potentially lasting impacts on the economy, with individuals facing the risk of cash flow problems or significant losses as the value of asset classes in which living annuitants are invested decrease”.

In an effort to alleviate these cashflow constraints and risk of poor performance in what is often people’s most important investment, the Minister of Finance, in draft government notices, has proposed amending the rules regulating the draw down rate and full remaining value lump sum withdrawals, from living annuity investments.

The current position

The relevant aspects of ‘Living annuity’ are defined in section 1 of the Income Tax Act 58 of 1962 as:

“a right of a member or former member of a pension fund, pension preservation fund, provident fund, provident preservation fund or retirement annuity fund, or his or her dependant or nominee, or any subsequent nominee, to an annuity purchased from a person or provided by that fund on or after the retirement date of that member or former member in respect of which -

 (a)    the value of the annuity is determined solely by reference to the value of assets which are specified in the annuity agreement and are held for purposes of providing the annuity;

(b)     the amount of the annuity is determined in accordance with a method or formula prescribed by the Minister by notice in the Gazette;

(c)     the full remaining value of the assets contemplated in paragraph (a) may be paid as a lump sum when the value of those assets become at any time less than an amount prescribed by the Minister by notice in the Gazette;”

The draw down rate – determining the amount of the annuity as per paragraph (b) of the above definition – is prescribed by GN290, Government Gazette 32005 of 11 March 2009 (GN290), as being between 2.5% and 17.5% of the total value of the assets referred to in paragraph (a) of the above definition. GN290 further prescribes that annuitants may only select a different draw down rate on the anniversary date of the inception of the annuity and at no other time.                         

Paragraph (c) of the above definition provides for the lump sum withdrawal of the full residual value of the invested assets where the value of those assets is below the threshold set in GN1164, Government Gazette 31554 of 30 October 2008 (GN1164). This threshold, where there has been a lump sum commutation, is R50,000 and R75,000 in any other case.

Proposed amendments

The draft government notices published by the Minister of Finance propose temporarily increasing the range of available draw down rates on living annuities to between a minimum of 0.5% and maximum of 20%, and for this to be altered freely by annuitants during this temporary period. The proposed period during which this is to be effective is from 1 May 2020 to 31 August 2020.

Annuitants whose anniversary date falls within this period may elect to make use of the relief provisions or adjust their draw down rate in the ordinary course. Should the relief provisions be made use of by such annuitants, their draw down rate will automatically revert on 1 September 2020 and they will only be able to make a further adjustment on the next anniversary date.

The draft government notices further propose adjusting the threshold for the lump sum withdrawal of the full residual value of a living annuity (as provided for in GN1164) to R125,000 in all cases. This amendment is intended to be a permanent change to the regime.

Comment

The draft government notices were published on 25 April 2020, for comment by 28 April 2020. It is unclear whether the date for comment may be extended, considering that comments on the revised draft tax relief bills, which were released on 1 May 2020, can be submitted until 15 May 2020. In any event, the final parameters of the amendments remain to be seen. Furthermore, it must be noted that these amendments only relate to investments falling within the definition of “living annuity” in section 1 of the Act, as set out above.

In their current form, the proposed changes to the living annuity regime indeed provide relief, in that annuitants are given more options in terms of what they are permitted to withdraw, depending on their personal circumstances. Retirees currently receiving payments from living annuities will be granted more flexibility in determining the rate at which they receive funds from their investment over the short term. It also allows annuitants to withdraw their entire investment should it fall below the threshold amount, which may provide much needed liquidity.

The amounts withdrawn under the proposed amendments continue to be taxed under the provisions of the Act, specifically the Second Schedule to the Act. The increased or decreased amount received as a result of a change in the draw down rate, will be included in such annuitant’s “gross income” (as defined in section 1 of the Act). The amount received under a living annuity must be included in “gross income” under paragraph (a) of that definition and may be subject to certain deductions and exemptions.

The residual lump sum withdrawals are included in the taxpayer’s “gross income”, but under paragraph (e) of the “gross income” definition. The amount to be so included is determined under paragraph 2(1)(a)(iii) of the Second Schedule to the Act, subject to the relevant deductions contained in paragraphs 5 and 6 of the Second Schedule to the Act. Specific tax tables and tax rates (other than the normal marginal tax rate tables) apply to the amounts that accrue to the annuitant under these provisions.

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