Divorce Awards To The Non-Member Spouse - In A Nutshell. Where Are We Now?

Recent legislative amendments introduced the so-called clean break principle to retirement funds on divorce. This means that for all divorce orders, even those granted before 13 September 2007, the non-member would be entitled to payment of his/her share of the benefit immediately.

The idea is that the non-member would be able to invest the money in their personal capacity and enjoy the growth thereon, which seems on the face of it to be more equitable than the old regime. Further legislative amendments (The Revenue Laws Amendment Act 60 of 2008) have resulted in the tax on the benefit being treated differently depending on the date of the divorce.

The following circular was issued by: Jenny Gordon, Senior Legal Adviser at Old Mutual, which covers Divorce and the impact it can have on retirement fund benefits.

Divorce Awards To The Non-Member Spouse - In A Nutshell. Where Are We Now?

In the last two years, there has been much legislation dealing with the early payment of divorce awards to a non-member spouse from retirement funds.

The legislation has been in the form of amendments to the Pension Funds Act and to the Income Tax Act. Unfortunately, the Divorce Act which also needs to be amended remains unchanged.

With each amendment there were a number of problems. The retirement industry provided a great deal of input commenting and shaping the legislation. Sometimes their input was heeded. At other times it was not, which unfortunately, caused the process to be a long and protracted one.

We have now reached a stage where the content of the legislation still needs some small tweaks and certain interpretative issues still prevail, but we have a workable framework within which to operate.

This circular is not intended to be a technical discussion. It is intended to be a bottom line evaluation of the current status

The current position

1. An amendment to the Pension Funds Act effective 13 September 2007 allows a retirement fund, pursuant to an order of Divorce, to deduct a portion of the member’s pension interest from the member’s retirement fund and pay it to the non-member spouse or another fund on her behalf immediately on divorce. The non-member spouse no longer has to await the member’s exit from the fund.

2. The non-member spouse has to submit the order to the fund and initiate the claim.

3. On 1 November 2008 legislation was passed to allow the early payment mechanism to apply to divorce orders which are binding on funds and made before 13 September 2007.

The Taxation

1. An important part of the process was ensuring that the tax legislation was able to accommodate the early payment of such orders. In fact policy decisions needed to be taken to ensure that vested rights in relation to existing divorce orders were maintained and for equity of treatment to apply in the future.

2. A policy decision was made for divorce awards to be taxed in the hands of the non-member spouse in respect of divorce awards which accrue in the future. However, divorce awards in terms of divorce agreements which were concluded in the past and which were negotiated based on the law as it existed in the past would continue to be taxed in the hands of the member.

3. This policy decision has required a great deal of comment being provided by the industry in numerous drafts bills in the last two years.

4. The tax situation which will apply with effect from 1 March 2009 is summarized as follows:

Divorce orders made on or after 1 March 2009

The Revenue Laws Amendment Act of 2008 which came into effect on 8 January 2009 provides for the non-member spouse to be the taxpayer. This is confirmed in the Taxation Laws Amendment Bill of 2009 which is not yet law but which was released for comment on 20 February 2009.

If the non-member spouse elects to take the amount in cash, she will pay the tax at the rates set out in the new retirement fund lump sum withdrawal benefit tax table.

If she chooses to preserve the benefit by transferring it to another approved fund, she will be able to delay the tax payable until she withdraws or retires from that fund.

Divorce orders made between 13 September 2007 and 28 February 2009

The non-member spouse is obliged to submit the order to the fund and to elect whether she wants the benefit paid to her in cash or paid to another fund. The taxability of this will depend on when the divorce award accrues to the non-member spouse.

The date the non-member spouse makes her election is the date on which the fund must deduct the assigned amount from the member’s minimum individual reserve. It is also the date on which the amount accrues for tax purposes.

If the non-member spouse fails to make her election when she submits the court order, within 45 days thereof, the fund must ask her to make her election. If she still fails to do so the fund must deduct the benefit within 120 days and pay it over within a further 30 days. Again the date of deduction is the date of accrual for tax purposes.

If the date of accrual falls in the 2008/09 tax year (up to 28 February 2009) the member remains the taxpayer. Even if tax has not yet been paid over, tax is payable at the member’s average rate of tax. Two tax directives will have to be sought because a “tax on tax” liability has to be paid too. Unless the divorce agreement excludes it, the member has a right to recover the tax directly from the non-member spouse (excluding tax on tax).

However, if the election is only made after 1 March 2009, the tax accrual will fall into the 2009/10 tax year. As previously stated divorce awards which accrue after 1 March 2009 will be taxed in the hands of the non-member spouse under the new withdrawal tax table.

So in respect of divorce orders made after 13 September 2009, the taxpayer will change depending on when the deduction from the member’s minimum individual reserve takes place, which in turn depends on when the non-member spouse makes her election.

As mentioned, the non-member spouse can delay the payment of tax if she elects to transfer to another approved fund.

Divorce orders made pre 13 September 2007

A policy decision was made for the member to remain the taxpayer on the payment of divorce awards which were made prior to 13 September 2007. Divorce agreements were made in contemplation of the law as it existed then and parties to the divorce are entitled to have new laws applied prospectively and not retrospectively.

Unfortunately an unintended error crept into the Revenue Laws Amendment Act of 2008. Paragraph 4(4) of the Income Tax Act mistakenly makes the non-member spouse the taxpayer on pre 13 September 2007 orders although the explanatory memorandum clearly indicates that the intention is for the member to remain the taxpayer. The error has been corrected in the first draft of the Taxation Laws Amendment Bill of 2009.

SARS is providing tax directives based on the intended treatment and the member is treated as the taxpayer. If the election and therefore the accrual took place in the 2008/09 tax year the member pays tax at the average rate. Tax on tax is payable and the member has a right of recovery from the non-member spouse directly. If the accrual takes place on or after 1 March 2009, the member remains the taxpayer but the new lump sum withdrawal table will apply. Tax on tax will still be applicable.

GEPF

The GEPF does not fall under the Pension Funds Act. Non-member spouses still have to wait until the member exits the fund prior to receiving payment. Paragraph 2B still taxes those awards.

Comment

We trust that this note provides you with a simplified statement of a lengthy and complicated process. Bear in mind that both the member and the non-member are in need of advice in this process. The non-member needs to be encouraged to preserve and grow the lump sum. The member needs to supplement and compensate for the depleted retirement capital.

It is recommended that both the member and the non-member take proper legal advice on the implications of the divorce on retirement fund benefits and that the divorce agreement be as specific as possible as to the treatment of the retirement benefit on divorce.

Silke Financial Services are skilled risk and investment strategy consultants that provide a unique service offering not available elsewhere in the marketplace.