If you have not changed your employee benefits since 01 March 2015, you are paying too much!
A group income disability benefit is one of the core employee benefits provided by most South African employers. The importance of this benefit needs no further explanation and is considered almost as a “compulsory” benefit for any responsible employer. Where an employee becomes temporarily or permanently disabled, there must be adequate cover to provide an income for the period of disability up to retirement. Recent tax changes on income disability benefits have now made this benefit a far more complex item on the payroll than in comparison to previous years where most employers provided a minimum flat benefit equal to 75% of insured salary. Simply put, in many cases, employees are paying for a level of benefit they would possibly not be able to claim due to certain restrictions.
The standardisation of the tax treatment of employer-owned policies, including income continuation or income protection policies, was introduced by the Taxation Laws Amendment Act of 2013 (“2013 TAA”) that came into effect on 1 March 2015. This signalled the end of tax effective structuring on employee insurances, as other insurances such as dread disease, funeral cover, accident cover, road side assistance and so forth have been taxable for a couple of years now.
Numerous articles and member communications have been written on this topic and the main focus up to now was the fact that employees would no longer receive a tax deduction of their income replacement premiums from 01 March 2015 onwards, and would therefore have a higher taxable income and lower take-home pay. This applies to all individuals covered by their own or their company’s income replacement policy. Most employees have already seen the impact of this change on their monthly payslips. If you have not seen this, you are non-compliant on employees’ tax.
The justification for this change was that even though employees would no longer get a tax break on their premiums, the benefit, if circumstances ever allowed, would be paid out to the employee tax-free. Realistically, and in contradiction to the above justification, the majority of employees are less than likely to become disabled during their working lifetime and would, therefore, not benefit from the tax saving on the benefit payment. On the other hand, this new dispensation will benefit SARS, as they now collect tax on a benefit which will rarely be claimed tax-free.
Although the new tax change does come across as disadvantageous, there are, however, two instances where the new tax dispensation holds clear advantage:
– Where an employee became disabled prior to 1 March 2015, he/she would have claimed tax deductions on their contributions, but will also receive a tax-free income disability benefit from 01 March 2015 onwards; and
– Many employees were simply under-insured up to now and especially where no flexibility of benefits was offered. The new treatment means more take-home pay from the income disability benefit, thus getting the employee closer to being adequately covered.
National Treasury explanation
In the Explanatory Memorandum to the 2013 TAA, and under the reasons for the change, it is stated that: “both life and disability insurance essentially have the same objective – to protect the financial future of an individual and his or her family through insurance against an adverse personal event. The amount of cover chosen is designed ultimately for future “income” protection whether the payments come in the form of a lump sum for reinvestment (with reinvestment earnings providing the desired safety) or as an annuity.”
This statement is based on the assumption that the policyholder or the beneficiary in the case of a group scheme has a choice in the amount or level of cover to be chosen.
The reality is that the majority of companies in South Africa, even though they remunerate on a cost-to-company basis and risk premiums ultimately form part of the employee’s package, provide no or very limited flexibility when it comes to retirement provision and other employee benefits.
Typically, a one-size-fits-all approach with very little regard to the employees’ personal financial circumstances is offered to employees. According to the 2015 Sanlam Benchmark Survey for Standalone Retirement Funds, the majority of participants provide an income disability benefit of 75% of salary, or which is calculated on a sliding scale basis. Further, the insured salary is either equal to basic salary or a fixed percentage of cost-to-company (“CTC”). None of the participants in the survey have indicated that they currently offer flexible levels of income disability cover.
Get with the programme – you must give choice
This tax change highlights the need for giving consideration to employees’ personal circumstances in the design of benefit schemes. For example, if a certain level of net, after-tax benefit was acceptable to an individual in the past, the mere fact that Treasury has changed the tax rules, does not impact on the financial need of that same individual.
That said, it is a well-known fact that South Africans are grossly under-insured. Even where employees are covered under an employer group policy, the majority of companies in South Africa calculate risk benefits on a fund or risk salary that is significantly lower than the employees’ CTC. For example, where the employee’s risk salary is calculated as 70% of CTC, an income disability benefit of 75% of salary would only amount to a benefit of 52.5% of CTC.
Paying for something you can never claim?
There is however a far greater concern, one which very few employee benefit brokers or administrators seem to clearly communicate.
A published communication from one of the major insurers around the tax changes, made the following simplified statement: “You will be receiving a greater disability benefit in future because there is no more tax payable on the benefit post 1 March 2015 – all because SARS is trying to simplify overall tax structures.” (Author’s emphasis)
The same insurer in a later communication, noted that: “it is still important to ensure that disability income benefits do not exceed a person’s total guaranteed package after tax” and “this will be reflected in all – Income Protection policies as a maximum benefit”.
What’s in the fine print?
Although an employee or claimant may receive a greater benefit due to the removal of tax, the same employee may be paying a premium for a benefit that he/she may never enjoy. To explain, assume an employee receives a salary of R100,000 and an income protection benefit of 75% of salary. On an assumed tax rate of 30%, the current monthly take-home pay will be R70,000. After 1 March 2015, the maximum benefit payable by the insurer and applying their maximum levels, would be R70,000. This means that whilst the employee pays for insurance of R75,000 per month, the insurer will only pay R70,000.
Another insurer has indicated that they will cap their income replacement benefit at 75% of Guaranteed Package less income tax. The principle they apply here is the same as the one previously applied by the Life Office Association (“LOA”) which suggests that an individual should not be in a better financial position when on disability than when actively working. And although this is a noble stance, the same insurer would not refuse to accept premiums that has been calculated on the full benefit of R75,000.
Most insurers have already issued high-level communication to employer groups in suggesting ways to deal with this potential conundrum. One such example is an insurer who has provided a table that indicates the level of benefit required for each individual member to replace 100% of their net pay.
The examples provided assume a specific level of insured salary as percentage of cost-to-company, and suggest a different level of cover depending on the employee’s annual CTC. For example, an employee with a CTC of R60,000 per annum, and an insured salary of 80% of CTC, that is R48,000, should select an income replacement benefit level of 115% to replace 100% of their net pay and excluding an employer waiver of 10%. Another employee in the same group with a CTC of R500,000 per annum, should select an income replacement benefit level of only 85% to replace 100% of their net pay.
Most insurers provide this level of flexibility within their standard structures, however, they place the responsibility solely on the individual employee to determine the appropriate level of cover and to ensure they are not under- or over-insured. Even if the insurer could communicate the appropriate level of cover on an individual basis, chances are that the majority of employees would not understand this level of detail, or if they wanted to change their level of cover, that their employer would not be able to accommodate the level of flexibility on their payroll systems.
In a communication to employer groups, one insurer has suggested that as a first option, existing benefit structures should remain unchanged, and thereby the insurer benefits from premiums collected on over-insured benefits. Other suggested options were to reintroduce sliding scales, for example 75% of the first R7,500, plus 62% of the next R13,500, plus 56% of the next R15,000 plus 47% of the balance. Given that there would still be a mismatch in calculating the premium payable to the insurer and the ultimate benefit payable by the insurer, this does not seem like a feasible option either.
The third and probably most viable option would be a tax replicator whereby the current tax tables would be used to calculate an after tax benefit to insure. Similar to the suggested table above, this would require individuals to select their own levels of cover and a detailed calculation of the maximum benefit that they would qualify for. It would also require a possible change to the level of cover selected every time the income tax table changes. Employees with tax-deductible pension fund or retirement annuity contributions would also qualify for different benefits than employees with no contributions.
In these times, there can be arguably no greater sin than forcing employees to pay for a benefit they cannot claim. Make sure your employee benefits are optimally structured and that your advisors have no conflict in guidance which is always in the best interest of the employee.
Mentje Larney is a specialist benefit and tax consultant at Remuneration Consultants www.remunerationconsultants.co.za, and operates in a niche consulting capacity to various employers.
This article appeared in the October 2015 issue of HR Future magazine.