By Lowtax Editorial
18 April, 2013
This feature rounds up some of the key developments around the world with regard to the taxation of retirement savings and pensions.
Governments are facing something of a dilemma at the moment. While most countries attempt to motivate individuals to save for their retirement by offering various tax concessions, many of them have had to rethink the whole area of pension provision as they attempt to put public finances on a more sustainable footing in the long-term.
The result of this is that in the recent past, tax-privileged schemes in many countries have been gradually eroded, while frequent changes to the taxation rules surrounding pensions have tended to make the situation for those coming up to retirement, or currently trying to provide for their old age, ever more confusing.
Obama Budget Mixed For Pension Funds
President Obamas Budget Plan for the 2014 Fiscal Year is a good example of this.
On the one hand, the Budget attempts to reduce tax leakage from the pension system by capping the amount of money that individuals can hold in tax-privileged retirement accounts. But on the other, the President has proposed a tax break to encourage foreign pension funds to invest in US infrastructure projects.
The first proposal would limit the deduction or exclusion for contributions to tax-favoured retirement plans, including IRAs, 401(k)s, and defined benefit plans when the amounts in those plans exceed a maximum allowable benefit. The limit would be based on the amount needed to finance an annuity of USD205,000 per year in retirement. It would fluctuate based on inflation and interest rates and this year's account balance cap would amount to USD3.4m for a 62-year-old and USD3m for a 65-year-old.
According to the Employee Benefit Research Institute, only 0.03% of the 20.6m IRA and 401(k) accounts currently in existence held assets of more than USD3m. However, because under the proposed formula the cap could in future fall, many more account holders may need to become aware of this change.
The proposal would be effective with respect to contributions and accruals for taxable years beginning on or after January 1, 2014, and the Administration expects that this proposal would raise in the order of USD9bn in additional tax revenue over 10 years.
The second proposal would exempt foreign pension funds from the application of the Foreign Investment in Real Property Tax Act (FIRPTA).
Enacted in 1980, FIRPTA is intended to subject foreign investors to the same US tax treatment on gains from the disposition of US real property interests as that which applies to US investors. Thus, under FIRPTA, when a non-resident alien individual or foreign corporation sells an interest in US real estate (including directly held real property and stock in corporations that predominantly hold real property), any gain on the sale generally is subject to US tax.
The proposal would exempt from the application of FIRPTA gains of foreign pension funds from the disposition of US real property interests. For this purpose, a foreign pension fund would generally mean a trust, corporation, or other organization or arrangement that is created or organized outside of the United States that is generally exempt from income tax in the jurisdiction in which it is created or organized, and substantially all of the activity of which is to administer or provide pension or retirement benefits.
According to the White House: "Infrastructure assets can be attractive investments for long-term investors such as pension funds that value the long-term, predictable, and stable nature of the cash flows associated with infrastructure.
However, "under current law," it added, "gains of foreign investors from the disposition of US real property interests are generally subject to US tax under FIRPTA, and foreign investors, including large foreign pension funds, regularly cite FIRPTA as an impediment to their investment in US infrastructure and real estate assets."
"With US pension funds generally exempt from US tax upon the disposition of US real property investments," the Administration therefore "proposes to put foreign pension funds on an approximately equal footing, by exempting their gains from the disposition of US real property interests, including infrastructure and real estate assets, from US tax under FIRPTA."
It must be noted of course that even if Congress manages to agree a budget resolution which at the moment looks highly unlikely given the entrenched divisions between the two parties these proposals might not make the final version, and the resolution is in any case non-binding. However, the retirement account cap could figure in any future tax reform or deficit reduction legislation.
South Africa Revamps Pension Legislation
Much more fundamental changes to the rules governing pensions are taking place in South Africa, and in March 2013 further details were provided with regard to the Governments public consultation on its proposals to reform the countrys retirement industry, with a focus on the taxation, governance and harmonization of retirement funds.
The revised proposals and new consultation were announced by Pravin Gordhan, the South African Minister of Finance, in his 2013 Budget Speech on February 27. The proposals follow a series of technical discussion papers with draft proposals that were issued in 2012, after the Ministers 2012 Budget announcements.
Both formal and informal consultations were held with stakeholders during 2012 in respect of those papers, and the Government has now developed the revised policy proposals for further consultation with a closing date of May 31, 2013. Following that, draft legislation to give effect to the proposals will be introduced over the course of 2013.
Firstly, it was pointed out that South Africa is an outlier" among countries of a similar income level in that it does not have a statutory requirement for pension provision and, as a consequence, a large number of employers provide retirement and insurance funds as a condition of employment.
However, coverage of such arrangements is uneven, with workers access to an occupational fund dependent on factors such as income, employer size and economic sector. According to research based on the 2010 Labor Force Survey, only 32% of people earning below the tax threshold and only 36% of workers at companies with fewer than 50 employees have access to an occupational retirement fund.
The Governments contribution to occupational and individual retirement arrangements is seen as incentivizing contributions via the tax system, and regulating retirement funds. The reforms now being proposed are, in fact, also intended to lay the foundation for the eventual introduction of a mandatory scheme, being part of a comprehensive social security system that provides retirement cover to all workers.
With regard to the taxation of retirement funds, from an effective date in or after 2015, called T-day, employer contributions to retirement funds will become a fringe benefit in the hands of employees for tax purposes.
Individuals will be able to receive a tax deduction on employer and employee contributions to a pension fund, provident fund or retirement annuity fund up to 27.5% of the greater of remuneration and taxable income. For equity reasons, an annual ceiling of ZAR350,000 (USD39,600) will apply.
The tax treatment of contributions to pension, retirement annuity and provident funds will be harmonized, allowing provident fund members also to receive a tax deduction on their own contributions. Vested benefits would be protected in provident funds at the date of implementation.
However, it is proposed, subject to public consultation, that future contributions made to provident funds after an agreed date would be subject to the same annuity requirements applicable to retirement annuity and pension funds. That requirement would not apply to provident fund members older than 55 years at the date of implementation.
Contributions in excess of the annual caps may be rolled over to future years. At retirement, where any non-deductible contributions remain, they would be set off against any lump sum or annuity income before tax is calculated, to avoid double taxation.
With regard to non-retirement savings, the Government intends to proceed with the implementation of tax-preferred savings and investment accounts. All returns accrued within these accounts and any withdrawals would be exempt from tax.
The account will have an initial annual contribution limit of ZAR30,000 and a lifetime limit of ZAR500,000, to be increased regularly in line with inflation. The new accounts will be introduced by 2015, and will co-exist with the current tax-free interest income dispensation.
With effect from March 1, 2013, tax-free interest-income annual thresholds will be increased from ZAR33,000 to ZAR34,500 for individuals 65 years and over, and from ZAR22,800 to ZAR23,800 for individuals below 65 years. These thresholds may not be adjusted for inflation in future years.
Austria Modifies Pension Deduction; Challenges German Tax Ruling
Austria has been the focus of two interesting developments in pension taxation over recent weeks.
Firstly, in February, Austrian lawmakers adopted modifications to pension deductions in the income tax system.
Under existing rules the increased pension deduction or PAB has only been accorded to pensioners with gross monthly pension income of up to EUR1,750 (USD2,296). For any pensioners with gross monthly pension income in excess of EUR1,750, the standard pension deduction has applied. Under the new provisions, the increased pension deduction will be gradually phased out up to a gross pension amount of EUR2,200, when the higher tax break will end.
Underlining the importance of the changes, Austrias Finance Minister Maria Fekter emphasized that the new provisions will lead to greater sustainability in the tax system.
Defending the plans, Finance Minister Fekter, Social Minister Rudolf Hundstorfer and Financial State Secretary Andreas Schieder provided concrete examples, highlighting the problem with the current system. At the moment, pensioners with gross monthly pension income of EUR1,750 receive EUR1,455 in net pension income, while those with gross monthly pension of income of EUR1,760, receive just EUR1,418 per month.
Phasing out the increased pension deduction will mean that pensioners with gross monthly pension income of EUR1,760 will, in future, collect a net monthly pension of EUR1,449, EUR31 more than is currently the case.
Then, in April, it emerged that a change to tax law in neighbouring Germany will result in around 150,000 Austrians currently in receipt of a German pension paying taxes on their income, with retroactive effect from 2005. The move follows the decision to modify German legislation. The new legislation provides that German pensions paid out to foreign taxpayers will be subject to taxation in Germany.
The Austrian Finance Ministry intends to challenge the decision to seek hefty back payments and to seek a sustainable solution to protect low-income pensioners in particular. Wolfgang Nolz, the Austrian Finance Ministry's new capital markets presenter, is to lead a delegation to the German tax authorities in Neubrandenburg to request that tax exemptions, reductions, deferrals, or paying in instalments be allowed in certain such cases.
Nolz said that it is unprecedented in European history that a country suddenly decides to tax pensions and to seek arrears many years later. Some pensioners will be faced with huge tax bills amounting to several thousand euros a year, Nolz pointed out, insisting that it is simply not feasible for aging pensioners to settle this sum in one go.
The Austrian Finance Ministry aims to install an ombudsman by May to support those affected by the decision. Until then, Austrians may seek advice from the Austrian tax authorities.
Germany Takes a Bigger Slice From Pensioners
In Germany itself, Parliamentary State Secretary Hartmut Koschyk disclosed recently that more of the countrys pensioners are now subject to taxation as a result of changes to the system of taxing pensions almost 10 years ago.
These changes brought about the transition to a so-called system of deferred taxation (nachgelagerte Besteuerung), whereby benefits are no longer taxed with respect to the interest portion, but with respect to the remainder.
Introduced within the framework of the Retirement Income Act, the system of deferred taxation has applied in Germany since 2005 following a decision from Germanys Federal Constitutional Court.
The Court had ruled that the old system was unconstitutional as public service pensions were treated differently to annuities from statutory pension insurance.
Koschyk outlined details of the progressive transition to a system of deferred taxation, noting that the taxable portion of pensions is gradually being increased to 2039. For all pensions that began in 2005, or before January 1, 2005, (2004) the taxable portion stood at 50%. The taxable portion increases thereafter by 2 percentage points every year to 80% in 2020. From 2021 to 2040, the taxable share is to rise by a further 1 percentage point annually until finally pensioners entering retirement in 2040 are required to pay tax on the full amount of pensions (100% taxable portion). The transition to full deferred taxation will then be complete. Pension increases are taxed at 100%, however.
Koschyk emphasized that certain types of pension are now exempt from taxation, including pension income from statutory accident insurance, and from war pensions and severe disability pensions.
Parliamentary State Secretary Koschyk concluded by stating that the decisive factor in determining whether or not tax is due on pensions is the amount of income. If income exceeds the current basic allowance of EUR8,004 (USD10,337), this may then be subject to taxation (EUR16,008 for a married couple).
The German authorities are also said to be cracking down on pensioners failing to fulfill their tax obligations.
Claiming that it had access to internal statistics from the German Finance Ministry, Bild magazine said that the tax authorities had so far received 98 million documents from pension insurance companies. In 2008, the tax authorities collected almost EUR21bn (USD27.5bn) in taxes from pensioners
The number of taxpayers paying income tax and in receipt of a pension rose by one million to 2.82 million between 2004 and 2008, marking an increase of over 52%. Revenue from this group rose from EUR7.8bn to EUR20.7bn over the same period, according to the report, which noted that the average annual tax paid by those concerned stood at EUR4,480. The number of pensioners with purely pension-based income reportedly soared over the four-year period, rising from 7,720 in 2004 to 61,149 in 2008, with average annual pension tax bills standing in contrast at a mere EUR41.
UK Can Charge Tax on Management Fees
In a key decision published on March 7, The European Court of Justice agreed with the United Kingdom tax authority, HM Revenue and Customs, that value-added tax (VAT) is payable on fund management fees incurred by occupational pension funds.
Wheels Common Investment Fund Trustees Ltd had argued that a fund it managed on behalf of the Ford Motor Company should be treated as a "Special Investment Fund." Such funds, which are concerned with the collective investment in transferable securities of capital raised from the public, are exempt from VAT. However, although the fund in this instance represented the assets of several pooled pension schemes, the court ruled that it was not a fund open to the public, but rather "an employment-related benefit which employers grant only to their employees."
The court also observed that members of the scheme do not bear the risk of the management of the fund, and that the pension amount received is based on salary and length of service rather than on the assets' performance. Further, the employer is not comparable to a private investor: instead, "the contributions which he pays into the retirement pension scheme are a means by which he complies with his legal obligations towards his employees."
Hungary Refuses to Tax Pensions
Pensions are a particularly sensitive issue in Hungary right now after the Government fought off a case brought against it in the European Court of Human Rights following its decision to take control of the assets of mandatory private pension funds in 2010.
In February, Hungary rejected advice from the Organization for Economic Co-operation and Development (OECD) that the country should apply income tax to pensions, describing the OECD's recommendations as a foreign attack on the country.
A new OECD report, "Economic Policy Reforms 2013: Going for Growth," suggests that Hungary needs to make all pension benefits liable to income tax, as a measure to remove a disincentive to continued work at older ages. Further, the retirement age should be index-linked to increasing life expectancy and opportunities for early retirement for women and for those in certain professions should be closed off.
However, a spokesperson for the ruling Fidesz party was dismissive, warning that introducing a tax on pensions would put hundreds of thousands of Hungarians at risk, and claiming that pensions were currently outperforming inflation. The retirement age in Hungary is currently 62, and is due to rise to 65 by 2022.
The report also recommends higher energy and property taxes for high-income individuals, to finance reduced social charges and a new earned-income tax credit. According to the OECD, the credit should be more narrowly-targeted than a credit which was recently removed.
Canada Pioneers New Pension Vehicle
Meanwhile, the Canadian Government has been busy promoting its new pension vehicle known as Pooled Registered Pension Plans (PRPPs), intended to offer a new, low-cost, tax-efficient pension option to employers, employees and the self-employed. Under the scheme, workers will be able to "pool" their pensions through their administrators. Most of the administrative and legal burdens associated with a pension plan will be borne by a qualified third-party administrator, subject to a fiduciary standard of care.
Royal Assent was granted in July to the federal portion of the PRPP legislation, and the schemes will become available once the provincial governments have passed their respective legislation.
The first tranche of federal regulations was published in draft form in the Canada Gazette in August for a public comment period, prior to final approval by the government. Consultations were held with associations representing small businesses, employees, pension funds and financial institutions. According to Ted Menzies, Minister of State (Finance), the finalization represents an important step towards the creation of a new large-scale, low-cost pension option.
The regulations address a number of provisions of the Pooled Registered Pensions Act, as follows:
- Licensing conditions for potential plan administrators that provide an additional level of protection to individuals and employers seeking to join a Pooled Registered Pension Plan (PRPP).
- Investment rules that provide minimum safeguards to protect plan members interests, as well as flexibility to plan administrators regarding the investment and management of plan members funds.
- Investment choices that provide enough flexibility to plan administrators to offer members investment options of varying degrees of risk and expected return.
- Inducements that plan administrators will be allowed to offer and employers will be allowed to accept.
- Low-cost criteria that provide a balance between flexibility, to ensure that competition and disclosure will drive down costs, and the provision of a transparent comparator to be used by administrators and the Superintendent of Financial Institutions to determine what constitutes low cost.
- The rights and obligations of plan members and plan administrators with respect to setting the contribution rate to 0%.
- Information that plan administrators must disclose to plan members, employers and the Superintendent of Financial Institutions in order to facilitate transparency and comparability across PRPPs and support informed decision making.
A second and final tranche of regulations have now been pre-published for public comment. They relate to:
- General requirements with respect to providing information.
- The circumstances in which a member may withdraw funds from their PRPP account.
- The circumstances in which a member may receive variable payments from the funds in their account.
- The transfer options available to members and the conditions on the vehicles to which a members funds may be transferred.
- The use of electronic means to satisfy requirements under the Act for communications with plan members.
- Other technical rules related to the implementation of the framework.
Speaking at the National Summit on Pension Reform in February, Ted Menzies pointed out that an estimated 60% of Canadians do not have access to a workplace pension plan and that PRPPs are designed to bridge this gap.
Menzies called on the provinces and territories to introduce legislation to make PRPPs a reality. He stressed: "With the federal framework now fully in force, its up to the provinces and territories to implement their own legislation."
The British Columbian Government has duly obliged, tabling enabling legislation in the provincial parliament on February 28, 2013. At the time of writing however, it remains the only province to have done so.
Malta Lures European Pensioners
European Union-based retirees and savers tired at suffering tax increases and weary of the ever-changing tax environment could do worse than look to Malta, which has launched a generous tax incentive scheme to encourage European individuals to transfer their pensions to, and take up residence in the country.
Under the scheme, which is exclusively available to EU, European Economic Area, or Swiss nationals, income tax will be fixed at 15%, with a minimum tax liability of EUR7,500 per annum, plus EUR500 for each dependent.
To be eligible for the scheme, applicants would need to fulfil a number of conditions, including: purchasing a property worth at least EUR275,000 in Malta, or EUR250,000 in Gozo, or renting a property for EUR9,600 per annum in Malta, or EUR8,750 in Gozo.
Applicants must spend a minimum of 90 days in Malta per annum, averaged over a five-year period. In addition, they must not reside in any other single jurisdiction for more than 183 days in a year.
The individual's entire pension would have to be remitted and taxed in Malta, and 75% of the income chargeable to tax in Malta would have to arise from pension or similar income, including lifetime annuities, personal pension plans, and occupational pensions.
ConclusionUnfortunately, there probably isnt room for Malta to accept every disgruntled individual attempting to navigate a complex maze of national tax rules and other legislation in order to arrive at the best solution to provide for their retirement. Whats more, even though many Governments are now attempting to address the pension time bomb as a matter of priority, things dont look as if they are going to get any easier.
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