The effects of divorce on retirement funds, pension funds and provident funds in South Africa
It is of vital importance that the retirement fund clause in a divorce Settlement Agreement is drafted by an attorney who specializes in Divorce Law. It happens frequently that clauses are so badly drafted that a Fund rejects a claim. A substantive application to court is then necessary to rectify the bad drafting. The term ‘pension fund’ is both a generic name for all types of retirement funds that fall within the scope of the Pension Funds Act, and a descriptor of a specific type of pension fund, one in which at least two-thirds of the retirement benefit must be taken as an annuity. Other types of pension funds are provident funds, where the member may take the entire retirement benefit in cash, retirement annuity funds for retirement plans outside of the occupational/workplace environment, and preservation funds, to which benefits from a pension fund can be transferred.
One should never rush into dividing up pension and/or retirement funds in a divorce settlement. It frequently happens in divorce cases that pension fund administrators reject settlement agreements on the basis that the clauses dealing with the pension interest payout to a non-member spouse are drafted incorrectly. It is therefore of the utmost importance that the clauses dealing with pension pay-outs be drafted properly. If not drafted properly, application will have to be made to the court at great cost to amend or vary the settlement agreement.
The relevant provisions that control the allocation of unaccrued pension benefits to a non-member spouse upon divorce are contained in the Divorce Act and in the Pension Funds Act 24 of 1956.
A claim under the Divorce Act can only be brought where the husband/wife or a partner in a civil union is still a member of the fund. Once he/she exits from the fund, usually on retirement or as a result of an early withdrawal, the benefit accrues to him/her, and there is no longer any ‘pension interest’ or unaccrued benefit. If the benefit accrues before the date of divorce, it must be dealt with as any other asset in the separate or joint estate.
Where couples are married or in a civil union in community of property, each partner will have a claim against the other’s pension fund. The claim will be for half of the pension interest on the date of divorce.
The marital systems in South Africa and how they affect retirement fund claims
Marriages in community of property
The pension interests of the spouses will form part of the parties’ joint estate and the non-member spouse will be entitled to claim 50% of the pension interest of the member as at the date of the divorce.
Marriages out of community of property with accrual
Where couples are married out of community of property with the accrual, the spouse’s pension fund value will be taken into consideration in order to determine the value of his/her estate for purposes of the accrual calculation only.
Marriages out of community property without accrual before 1 Nov 1984
The spouses retain their own separate estates and there is no sharing of assets at divorce, unless a court orders a redistribution of assets in terms of Section 7(3) of the Divorce Act. A pension interest forms part of the spouse’s estate and will then form part of the assets if redistribution is ordered by the court. The parties may also agree to share the pension interest in a settlement agreement.
Marriages out of community of property without accrual after 1 Nov 1984
Here the spouses retain their own separate estates and there is no sharing of assets at divorce. Any share in the pension interest will have to take place by mutual consent. The parties may also agree to share the pension interest in a settlement agreement.
The clean-break principle
The Pension Funds Amendment Act, 2007, introduced the so-called clean-break principle for the treatment of retirement fund benefits upon the granting of a divorce decree. The Act allows retirement funds to deduct an amount or percentage upon divorce from a member’s benefit and pay it to the non-member spouse or to a retirement fund of his/her choice. The clean-break principle allows a non-member former spouse to access an agreed or court-ordered share of the member spouse’s retirement savings on divorce.
Any assigned amount may be paid from the member’s pension fund to a non-member spouse in terms of a divorce order granted under the Divorce Act, irrespective of the date of divorce, but may not be more than 100 per cent of the value of the member’s withdrawal benefit at the date of divorce. In order for the fund to make the deduction and payment to the non-member spouse, the fund must be ordered to endorse its records (make a note on the system) to such effect and/or to make payment to the non-member spouse. The non-member spouse can elect to receive a cash lump sum or to have the money transferred to an approved pension fund.
A fund is not allowed to deduct and pay over interest on the amount assigned to the non-member spouse (except where the fund does not pay the non-member spouse within the time frames stipulated in the Act).
The Government Employees Pension Fund (GEPF) was amended to introduce the clean-break principle with effect from 1 April 2012. In the past, the portion of a member’s pension benefit payable to a former spouse as part of a divorce settlement was only paid when the member spouse left the fund. With the new amendments, former spouses will now be able to receive their share of the pension interest soon after the divorce has been completed, either in cash or as a transfer to another pension fund. The new rules state that on the date of payment of a divorce benefit the GEPF will create a debt against the member that is equal to the amount payable to the non-member spouse. The debt amount will build up, with interest, up until the member exits the Fund (and it will be reduced to the extent that the debt is partially repaid over the member’s remaining period of service in the Fund). At the date of the member spouse’s exit from the fund the total value of the benefit will be determined, and will then be decreased by the outstanding amount of debt owed.
Pension interest
‘Pension interest’ is defined in the Divorce Act for every type of fund except a preservation fund. According to the Pension Funds Act, ‘pension interest’ is:
- Pension and provident fund - The benefits to which a member would have been entitled to in terms of the rules of the fund if his/her membership had terminated, due to resignation, at the date of the divorce.
- Retirement annuity- The sum of the member’s contributions to the fund up to the date of divorce plus simple annual interest at the prescribed rate.
- Preservation fund - The benefit a fund member would receive if his/her membership were notionally to terminate on the date of divorce.
It is possible to assign a rand value to a non-member spouse instead of a percentage of the pension interest, provided that the amount does not exceed the value of the pension interest. It is not fit to award interest on the pension interest allocated to the non-member spouse as this is statutorily regulated in the Act, which provides for growth on the allocated portion. Interest only commences running a few months after the date of divorce, if the allocated pension interest is not paid over within the statutorily prescribed time limits.
It is very important to know exactly what is meant by the term ‘pension interest’ in a divorce settlement that involves handing over retirement savings, whether the savings are:
- in a pension fund or in a provident fund sponsored by an employer, a trade union or an industry association; or
- a retirement annuity fund or a preservation fund sponsored or authorised by a financial services company.
The reason why it is so important is that pension interest applies only to the aforementioned funds and not to an annuity (a pension) bought at retirement, or to a former fund member’s retirement savings that are held in the fund until the former member retires.
In terms of the Pension Funds Act, a pension/retirement fund is obliged to give the non-member spouse the right to decide how the pension interest award should be paid out, i.e. as a lump sum in cash or reinvested into another retirement fund. On presentation of a valid divorce order, the fund normally has 45 days to request the non-member spouse to decide how the pension interest due to him/her must be paid. The non-member spouse has 120 days in which to make a decision.
When it comes to the pension interest claim, the following needs to be considered:
- Is the fund a preservation fund or not?
- Should the non-member take his/her award in cash or transfer it to another fund?
- If taken in cash, how will it be invested?
Pension interest can be excluded in an ANC. If marrying out of community of property with the accrual, the member spouse will need to expressly exclude the value of the retirement annuity or pension fund as at the date of marriage when drawing up the ANC.
How is pension interest calculated?
Pension interest in a retirement annuity fund is defined in the Divorce Act as ‘the total amount of that party’s contributions to the fund up to the date of divorce, together with a total amount of annual simple interest on those contributions up to that date’. The Pension Fund Act provides that the ‘total amount of annual simple interest payable in terms of the definition may not exceed the fund return on the pension interest assigned to a non-member spouse in terms of a decree granted in terms of the Divorce Act’. So, the non-member spouse is entitled to claim the lower of either annual simple interest (currently at an annual rate of 15.5 per cent) or fund return on the pension interest allocated to the non-member in terms of the divorce order.
The non-member spouse of a pension fund is only entitled to the accrual of fund return on his/her share of the pension interest from when he/she has submitted the court order to the fund and has made an election as to whether his/her share of the pension interest should be paid directly to him/her or transferred into another fund until the date of payment.
In a preservation fund, if a once-off withdrawal has already been made prior to the divorce, the value of the remaining investment (which will usually be represented by the death or disability benefit) can be used to determine the termination value.
Divorce settlement agreements
Citing the fund in the divorce settlement agreement
It is of vital importance that the correct name of the retirement fund is used at all times. Uncertainty as to which fund is intended may result in a situation where the fund will not pay out. Divorce settlement agreements are frequently drafted using the name of the insurance company that manages the pension fund instead of the fund itself. It is not sufficient to refer to the administrator (e.g. Old Mutual or Liberty pension fund), as these financial organisations usually operate numerous retirement funds.
Divorce Orders
The Divorce Order must contain :
(i) A specific reference to “pension interest” must be made as defined in the Divorce Act. If the fund is a preservation fund the order must read “pension interest” as defined in section 37D(6) of Pension Funds Act.
The following will generally not be binding: “pension fund”, “pension benefits”, “joint estate”, “member’s interest in the fund” or the “proceeds of the policy”.
(ii) The name of the Fund.
Where the fund is not named, it must at least be possible to determine from the wording of the order which fund the parties had in mind.
For example, the “fund of the member-spouse’s employer” would be ascertainable but the “Liberty pension fund” is not ascertainable since financial institutions operate several funds.
The Divorce Order must contain :
(iii) A specified percentage or amount of the pension interest must be
provided.
It must be clear from the order how much of the member’s pension interest has been assigned to the non-member spouse.
The following will generally not be binding:
- An order which stipulates that the pension interest must be divided equally will not be considered binding as it does not indicate that 50% of the pension interest has been awarded to the non-member spouse.
- “Any debts incurred by the non-member spouse after the date of divorce must be deducted from the pension interest” – compliance with a further condition of one of the parties cannot be enforced against the pension interest of a member.
Taxation of pension interest allocations
The non-member ex-spouse will pay the tax on the pension interest if he/she takes the benefit in cash. If it is transferred to another retirement fund, the transfer will be tax-free.
This is a very difficult area, according to the Pension Lawyers Association of South Africa, especially when the pension interest is considerable. Parties are therefore advised to obtain professional advice. The situation has changed several times in the past few years, leading to much confusion. At present, the pension interest deduction is taxable in the hands of the non-member spouse. However, the tax dispensation may vary for divorces already obtained, depending on the date of the divorce and on the date of election in terms of section 37D(4)(b). It is important that the settlement agreement clearly address the tax issue.
Income Tax – Income Tax Act (Second Schedule)
The deduction is made from the member’s minimum individual reserve in the fund at the time of the divorce. The date of the divorce order payment/deduction from the fund determines the tax implications.
Divorce Orders prior to 13 September 2007: Where the deduction was made between 1 Nov 2008 & 1 March 2008, the member was regarded as the taxpayer. The divorce award was taxed at the member’s average rate of tax and tax-on-tax was payable. Where the deduction was made after 1 March 2009, no tax is payable.
Divorce Orders after 13 September 2007: Where the deduction is made prior to 1 March 2009, the member is the taxpayer. The divorce award is taxed at the member’s average rate of tax and tax-on-tax is payable. Where the deduction was made after 1 March 2009, the non-member spouse is the taxpayer.
Parties cannot enter into an agreement regarding the tax contrary to the tax legislation. If for example the non-member is the taxpayer the parties cannot agree that the member should be treated as the taxpayer. The parties may agree that in determining the quantum of the divorce award, the tax must be deducted from the award prior to the payment to the non-member spouse. Where the member is the taxpayer and the divorce order specifically states that the non-member spouse must be paid a net after tax amount, the tax due by the member must be deducted from non-member spouse’s share before paying him/her. Where tax on the divorce award is paid from the member’s remaining value in the fund, he/she may recover such tax from the non-member spouse. The Income Tax Act does not mention such a right to the member, but the parties are free to come to an arrangement regarding the recovery of tax. The member can however not recover tax-on-tax that was paid from his/her remaining value in a retirement fund. The tax due on the divorce award is regarded as a lump sum accrual in the hands of the member and hence the tax thereon cannot be recovered from the non-member.
How much tax must be deducted?
Taxable Income (R) Rate of Tax (R)
0 – 25 000 0% of taxable income
25 001 - 660 000 18% of taxable income above 25 000
660 001 - 990 000 114 300 + 27% of taxable income above 660 000
990 001 and above 203 400 + 36% of taxable income above 990 000
Download the SARS 2017 Tax Guide below.
Retirement fund lump sum withdrawal benefits consist of lump sums from a pension, pension preservation, provident, provident preservation or retirement annuity fund on withdrawal (including assignment in terms of a divorce order). Tax on a specific retirement fund lump sum withdrawal benefit (lump sum X) is equal to –
- tax determined by applying the tax table to the aggregate of lump sum X plus all other retirement fund lump sum withdrawal benefits accruing from March 2009, all retirement fund lump sum benefits accruing from October 2007 and all severance benefits accruing from March 2011; less
- tax determined by applying the tax table to the aggregate of all retirement fund lump sum withdrawal benefits accruing before lump sum X from March 2009, all retirement fund lump sum benefits accruing from October 2007 and all severance benefits accruing from March 2011.
Retirement fund lump sum withdrawal benefits consist of lump sums from pension, pension preservation, provident, provident preservation or retirement annuity funds on withdrawal (including assignment in terms of a divorce order). The taxation of an allocated pension interest is complex and both the member and the non-member spouse should seek professional advice in this regard. The taxation of retirement benefits, both before and at retirement, was amended several times in the past few years and may change again in the future. Currently, any allocation of a pension interest subtracted by the fund is taxed in the hands of the non-member spouse. In a case before our High Court a non-member spouse lost approximately R135 000 of her share of a pension interest of R300 000, for the reason that the divorce settlement did not clearly address the tax issue. In terms of the divorce settlement, the non-member spouse was allowed 30% of her ex-husband’s pension interest. The retirement fund paid over her share of about R300 000 and deducted a further R135 000 from her former husband's pensionable interest. The tax deduction was in terms of a provision in the Income Tax Act that, when a non-member spouse’s portion accrued, the member spouse was liable to pay the income tax. The same legislation confers on the fund member a right to recover the tax from the non-member spouse. In this case, the fund member instituted legal action against his former wife to recover the income tax that he had paid, effectively on her behalf. She disputed liability, contending that, on a proper interpretation of the settlement agreement this was not permissible. Her defence failed and the former husband's claim succeeded. The judge held that her former husband's right to recover the tax paid was not based on contract but arose in terms of legislation.
Legislation
Divorce Act 70 of 1979
“Pension Interest” is defined as follows:
Pension & Provident Fund:
The benefits to which a member would have been entitled to in terms of the rules of the fund if his/her membership had terminated, due to resignation, at the date of the divorce.
Retirement Annuity:
The sum of the member’s contributions to the fund up to the date of divorce plus simple annual interest at the prescribed rate. Interest as prescribed in the Prescribed Rate of Interest Act is currently 15.5%. Interest may not be more than the fund return.
Preservation Funds:
Section 37(D)(6) of the Pension Funds Act now reads: “the portion of the pension interest of a member of a preservation fund that is assigned to a non-member”
Pension Funds Amendment Act 11 of 2007
This act introduced the “clean break” approach whereby payment may be made to the “non-member spouse” immediately after divorce.
Section 37D(1)(d)(i):
“A registered fund may -
(d)(i) deduct from a member’s benefit or minimum individual reserve any amount assigned from his/her pension interest to a non-member spouse in terms of a valid court order;
Pension Funds Amendment Act 11 of 2007
Section 37D (1)(e):
“for the purposes of section 7(8)(a) of the Divorce Act, the pension benefit referred to in that section is deemed to accrue to the member on the date of the court order: Provided that-
(i) such deduction shall be effected by the pension fund named in the order upon receipt of the order;
(ii) such deduction shall have the effect of reducing the accrued benefit at the date of such deduction;
(iii) the non-member spouse shall have the option to elect that the assigned amount be paid directly to him/her, or that it be transferred to an approved pension fund on his /her behalf, and such transfer or payment must take place within 60 days of such election having been exercised;
(iv) the non-member spouse shall not acquire the rights of a member or beneficiary in relation to the pension fund; and
(v) the non-member spouse shall be entitled to the accrual of interest on the assigned amount at fund return from the expiry of the period referred to in subparagraph (iii) until payment or transfer thereof, but not to any other interest or growth”
Financial Services Laws General Amendment Act 22/2008
The amendment in the Pension Funds Amendment Act did not clearly set out the retrospective application and it was generally considered to apply to divorce orders after 13 Sep 2007, being the effective date of the Act.
This view was challenged in the case of Cockcraft v Mine Employees Pension Fund where the Pension Fund Adjudicator indicated that it was her view that the intention of the legislature was to make the amendment retrospective.
The Financial Services Laws General Amendment Act confirmed the position: All pension interests awarded in divorce orders issued prior to 13 Sep 2007 are deemed to accrue on that date. The “clean break” approach was therefore now effectively applied to all divorce orders. (Confirmed in section 37D(1)(a) of Pension Funds Act)
Financial Services Laws General Amendment Act 22/2008
The Act also amended section 37D of the Pension Funds Act further:
(i) The fund must ask the non-member spouse how the benefit is to be paid, within 45 days of receiving the divorce order;
(ii) The non-member spouse must notify the fund within 120 days whether the amount must be paid in cash or transferred to another retirement fund;
(iii) The fund must give effect to this election within 60 days;
(iv) Interest is payable on the amount from the expiry of the 120 day election period;
(v) Where the non-member spouse does not make the election within the 120 days, the fund must make the payment in cash within 30 days thereafter.
(Incorporated in section 37D(4)(a) and (b) of Pension Funds Act)
Compulsory Annuities Payable after retirement
Compulsory annuities paid to a member after retirement can not be included in a divorce settlement.