The social security and retirement reform discussion paper has given an outline of what South Africans can expect from the social security system, which should be be introduced in 2010.
How will I contribute?
The contributions will be compulsory and will be collected by the South African Revenue Service (Sars) from the employer. It is recommended that all employed people pay 15% of before-tax income into the fund; however, this will have a cap of R750 based on the Site-tax threshold of R60 000. In other words, anyone earning more than R60 000 will only pay R750 to the fund. But they will also have to pay some additional mandatory amount to a private occupational or individual retirement fund to ensure they have appropriate provision for insurance and income replacement in retirement.
This does indicate that death and disability contributions could also be made compulsory, although these are already usually included in a pension fund.
At the same time, the treasury has proposed a wage subsidy for people earning less than R45 000 a year. This will cover the costs of social security contributions.
While formally employed people will be the first to be signed on to the fund, compulsory contributions by household employees such as domestic workers as well as the self-employed will be phased in over time.
How will I benefit?
Everyone who has contributed will receive a pension on retirement as well as death and disability benefits. It will be run as a defined contribution fund. In other words, however much an earner contributes over their lifetime will determine how much they will receive back with growth on retirement. In this way there is no cross-subsidisation in the investment portion. Cross-subsidisation will be done through the wage subsidy. There will, however, be a cross-subsidisation of risk benefits as the profile of the average member will determine the death and disability benefits. Individuals whose risk levels are lower than the national average will effectively pay more for these benefits. But treasury says “the cost of death and disability benefits in the social security fund are not expected to be significantly different from the cost of such risk benefits in occupational pension funds. Cost efficiencies will be supported by a larger risk-pool and economies of scale in administration.” The old-age grant will remain as a retirement income “floor” and treasury is considering abolishing the means testing that could see all South Africans entitled to this basic income on retirement, in addition to their investment in the social security fund.
How will it affect my tax?
While the Income Tax Act may still change, as it stands this contribution should be tax deductible in line with current retirement funding. Those individuals who are contributing should not see an impact on their take-home pay. As this will be mandatory, those who are not currently contributing will be forced to do so and the tax offset will be as far as the individual’s marginal tax rate.
For example, if your marginal tax rate is 30%, the social security fund will reduce your take-home pay by R525 if you are not already contributing to a fund. For individuals who earn less than R45 000 the government, through the wage subsidy, will pay towards the contribution.
If you earn R40 000 a year, you will contribute R500 a month, of which R91 will be offset by a wage subsidy, so the total payment from salary will be R409.
It would, however, be naive to think that the burden of the wage subsidy, which is estimated to cost in the region of R20-billion to R30-billion, will not cost taxpayers. There is a question of how the wage subsidy will be financed. Currently the tax deductibility of pension funds costs the government in the region of R20-billion a year. If government lowered the percentage, or put a cap on the amount that was tax deductible, this could create additional revenue to offset the wage subsidy. Higher income earners who currently contribute to a pension fund using their maximum tax benefit may find an increase in their tax burden.
How will it be administered?
This is where the real challenge lies. As Finance Minister Trevor Manuel admitted, a lot of work still needs to be done to get our systems prepared for such a wide social security system.
The financial industry will be most interested in who will administer the money and manage it.
While it is clear that Sars will collect the money, how it is handled from there is yet to be decided. The options range from one central fund run by government to a portion of the funds being outsourced as is the current model with the Public Investment Corporation, or the Chilean model where individuals are offered a list of preferred providers to choose from.
As we already have a world-class pension industry, which could probably handle the administration around the investments, the real challenge will be for Sars to get more people into the collection net. They know about the 4,9-million tax payers on their system, but what about the rest of the population? With a home affairs department that is so thoroughly inept there will be a major challenge getting the less formally employed on to the system.
For businesses, this is where the real costs will come in addition to more red tape. Treasury is hoping that the wage subsidy will help offset the costs of bringing these people into the formal sector. For example, an employer employing a part-time worker earning less than R15 000 a year will receive a wage subsidy of R375 a month. Only R188 will go to the social security fund, the rest will offset the employment costs for the employer. Then what about domestic workers? They would also require wage subsidies, but how would this be managed on a household to household basis?