What is the best way to provide retirement benefits to a domestic employee? This is a question Personal Finance readers often ask. There is no easy answer. The answer is complicated by tax issues, access to savings, job security and the debt levels of your employee.
The first issue to consider is how much you should contribute to the retirement savings of an employee. Again, there is no simple answer.
Jenny Gordon, a senior legal adviser at Old Mutual, says in terms of tax law and practice, employers and employees enjoy tax deductions for contributions they make to retirement savings up to certain limits. Usually an employer can contribute up to 20 percent of an employee's pensionable income towards that employee's benefits (medical scheme and retirement fund contributions), and an employee can contribute up to 7.5 percent of pensionable income to a retirement fund.
However, as an employer of a domestic worker or gardener, you do not enjoy any tax deductions for remuneration paid to that worker, or for retirement fund contributions paid on that employee's behalf. There is also no tax benefit for domestic employees who contribute to retirement funds, unless they are taxpayers. Anyone under the age of 65 who earns less than R32 222 a year does not pay tax.
How much should you contribute?
To start with, I suggest a contribution of 10 percent of pay, and for every R2 you contribute, your employee should contribute R1. This would bring total retirement contributions to 15 percent of your employee's income.
Domestic workers often do not enjoy long-term employment with one employer, or they have multiple employers, which can affect the type of retirement savings vehicle you choose, particularly those that are contractual and to which the payments may not be maintained.
Gordon says it is advisable for you and your employee to sit down with a financial adviser to make sure you choose the most suitable investment.
She suggests that the chosen investment plan be documented in the employment contract between you and your employee. (Remember you are legally required to have a contract with your employee). By including a retirement benefit in an employment contract, you and your employee can agree on terms, such as what happens to the investment if your employee resigns, is retrenched, dismissed, absconds or retires.
If this is written into an employment contract, you can ensure that the accumulated savings are earmarked to provide a pension and "are not raided at an earlier stage".
Gordon says that if you want to make sure that your employee does not spend the capital when he or she leaves your employ, or at retirement age (which would have to be recorded in the contract), the accumulated savings can be used to buy an annuity (a pension) from a life assurance company. This would ensure a continued income stream for the employee.
Six ways to save for your employee's retirement
There are a number of ways to save for retirement, but only some may be appropriate for a domestic employee. The options include:
1. Bank savings accounts
Advantages
- Costs are fairly low, which is important as high charges dramatically reduce the return on small amounts of monthly savings.
- No tax consequences as the employee is unlikely to be in a tax-paying income bracket. Even if your employee is paying tax, the first R11 000 in interest earnings in a single year is tax free.
- Relatively small amounts can be contributed.
- Payments can be discontinued if employee leaves employment.
Disadvantages
- Low interest rates, particularly in the early years, when balances will be low. Costs are likely to come close to interest payable.
- Not inflation proof. Historically, interest-earning investments have lower returns than the average inflation rate. This means that the real value of the money will reduce.
- The money is not locked in until retirement and can be drawn at any time by your employee. (Unless the employment contract stipulates otherwise.)
- You are not forced to contribute regularly. (An employment contract can impose such an obligation.)
- No security for employee. You may end up regarding the money as yours to dispose of (unless it is in the employee's name or in the employment contract).
- Creditors can lay claim to any savings. If the employee has debt problems, the money you put aside for the retirement of your employee can be snatched by a loan shark.
2. Unit trust funds
Gordon says unit trusts can be registered in the domestic worker's name. Alternatively, the unit trust fund can be registered in the employer's name, and once the domestic worker leaves, the units can be transferred into his or her name. You can make unit trust deposits as and when you want to.
Advantages
- Moderate costs account for about five percent of every premium and then between one and two percent of the asset value a year.
- No tax consequences as the employee is unlikely to be in a tax-paying income bracket.
- Investment choices are fairly wide with access to investments in equity markets. This is an advantage as historically equity investments have out-performed inflation.
- Low premiums. Some funds accept very low recurring premiums. The lowest are Stanlib Wealthbuilder and Sanlam General Equity, which both accept recurring premium amounts of R50 a month.
- Can be discontinued if your domestic worker leaves employment and is unable to take over the monthly investment amount. The amount already invested will not be lost.
Disadvantages
- The money is not locked in until retirement and can be drawn at any time by your employee. (Unless the employment contract stipulates otherwise).
- You are not forced to contribute regularly. (Unless the employment contract stipulates otherwise).
- Creditors can lay claim to any savings in the employee's name.
3. Assurance savings (endowment) plan
An important feature of a life assurance endowment policy is that it is contractual, so there is a built-in incentive to continue paying premiums during the premium-paying term. An endowment has a minimum investment period, which should not be less than five years, and the earliest your employee can be paid out is at maturity or upon his or her death.
Advantages
- Investment choices can be fairly wide, from equity markets to capital guaranteed portfolios.
- First R50 000 in capital is potentially protected against creditors in some circumstances.
- Regular contributions must be made, and there are penalties for early withdrawals.
- Can add risk cover against death and/or disability.
- Can add premium protection cover in case the policyholder is disabled or dies before the end of the term of the policy.
Disadvantages
- Fairly high costs, particularly on low premiums.
- Comparatively high premiums (some start at R250 a month).
- Penalties for early withdrawal. If you take out the endowment in your employee's name, but pay the monthly premiums, the domestic worker owns the investment, but might not be in a position to continue paying the premiums if she leaves your employment before the term has expired. If the endowment was taken out in the employer's name, the domestic worker may not be entitled to the policy unless the employment contract provides for this.
- Your employee indirectly pays tax because tax is paid on investment returns by life companies. This reduces the return.
4. Assurance savings plan (sinking fund)
An assurance sinking fund is similar to an endowment but the term of the investment is not affected by the death of the policyholder. There is often no minimum investment term.
Advantages
- Investment choices can be fairly wide, from investments in equity markets to capital guaranteed portfolios.
- Fairly low monthly payments (as low as R125 a month or a lump sum investment of R5 000.
Disadvantages
- Premium payments may be stopped or reduced at any time.
- Possible penalties for early withdrawal. Funds invested may be withdrawn at any time, but the growth portion may be forfeited if funds are withdrawn before five years. You must check with the product provider as different companies apply different penalties, with some applying no penalties on sinking funds.
- Life companies pay tax on investment returns on your behalf, thereby reducing your return, whereas your domestic employee may not be in a tax-paying income bracket and have no tax liability. As a result, your employee indirectly pays tax.
5. Retirement annuity (RA) policies
An RA is effectively a tax-incentivised savings plan for individuals. In return for the tax breaks, the savings cannot be accessed until age 55.
The problem is that your employee is unlikely to be paying tax. The tax threshold, or amount of income you must earn before you pay tax is R32 222 a year or R2 685 a month. So an employee earning less than this will not be able to deduct contributions to an RA and hence get no tax benefit from contributing to one.
And you, as an employer, will not receive any tax breaks for contributing to an RA on behalf of an employee. You are not allowed to deduct what you pay for domestic help and for providing benefits to domestic employees as an expense against your taxable income.
Advantages
- Investment choices can be fairly wide, from equity markets to capital guaranteed portfolios.
- Total amount protected against creditors.
- No withdrawals are permitted before the age of 55.
- At least two-thirds must be taken as a monthly pension.
- Can add risk cover against death and/or disability.
Disadvantages
- Fairly high costs, particularly on low premiums.
- Recurring-premium contributions start at about R250 a month.
- Tax consequences as life companies pay tax on your behalf on any interest earnings, at a rate of 18 percent. The maturity amount could also be subject to tax in the hands of the recipient.
6. Your own pension plan
You could take 10 percent of your employee's salary and add it to your regular contributions to one of your investments. You will need to keep a separate record of the accumulated savings and the growth on your employee's portion of the investment. When your employee retires, you can then use the portion attributable to your employee to buy an annuity (pension) from a life company.
Advantages
- Total amount protected against creditors of employee, but not your creditors.
- You can prevent withdrawals.
- You buy a voluntary pension for your employee with the saved amount at retirement of the employee.
Disadvantages
- Difficult to administer.
- Tax consequences for you as you could be exposed to income tax on interest, capital gains tax at maturity of the investment, or donations tax, unless it is an obligation recorded in an employment contract.
- Your employee has no protection against you pocketing the money (unless covered by an employment contract).
How about a compulsory scheme?
I do not know how many domestic employees there are, but I would imagine that there are hundreds of thousands. It would be worth government and the financial services industry (along with trade unions) getting together to create some type of compulsory scheme, with tax breaks that would make it attractive for both employer and employee.
How about it, Mr Manuel?
There are ways to meet the retirement needs of low-income earners, such as domestic and farm workers. These are my suggestions for Finance Minister Trevor Manuel, based on discussions with people in the industry and recommendations for the redrafting of the Pension Funds Act.
1. Make membership of a retirement fund compulsory for all employees, no matter what their income.
2. Create a legal framework that allows low-income earners to start and stop contributions so that they can stop contributing when they are out of work (as is often the case).
The life industry counts itself out because it insists on paying sales people upfront commissions and then penalising policyholders if they stop paying contributions. Better options would be:
- A national retirement fund, under the auspices of the Financial Services Board, with a board of independent trustees, with services, such as asset management, out-sourced to the private sector; and/or
- The unit trust industry, which is geared towards stop-start payments, and does not pay upfront commissions.
3. The worker is limited to being a member of one fund but is free to move from, say, one unit trust provider to another. As all the costs associated with a unit trust are paid as-and-when contributions are made, there would be no incentive to advise investors to change vehicles for the wrong reasons.
4. Allow the life industry to provide basic life cover and particularly funeral assurance. If funeral assurance is attached to compulsory membership of a retirement fund, it would be easier to regulate funeral assurance and protect consumers from scams.
5. Give all employers a tax rebate for making employee contributions to a retirement scheme within pre-determined limits.
6. Set a compulsory minimum for contributions, probably five percent of pay, and gradually ratchet it up to at least 10 percent.
Thanks to Old Mutual for assistance with this article. Incidentally, on the Nedbank Ten Investment Plan, which is a sinking fund, costs are a low 2.5 percent a year of the fund value, with no commissions as it is sold by bank employees. A product structured in such a way is worth your consideration within the current tax regime.