Considerations to ensure such a solution is successful
In coming up with this solution, we considered six conditions that would make it work effectively:
- Where possible, the emergency savings option should be the default one. If the member chooses to opt out of this, then whatever they would have been paid towards the savings portion will simply go straight towards the retirement fund.
- The solution needs to be easy to use and easy for members to understand.
- Payroll must channel after-tax funds directly into the savings plan before paying salaries to employees.
- Members must have an ongoing view of their overall short-term and long-term savings.
- Members need to have easy-enough access to their funds in case of an emergency. However, to discourage them from using these savings for day-to-day use they should not be able to withdraw their savings too easily (by using an ATM, for example).
- Members must be able to access financial guidance.
Employers and employees need to appreciate that this type of solution is sustainable only if savings are not withdrawn frequently. If the emergency savings plan is used as a bank account and savings are withdrawn every other month, then it will not be viable. Employers could put rules in place for accessing the savings portion; however, unless the savings are pooled in some internal mechanism, members will have the right to access their money according to the rules of the savings vehicle used.
And the more access rules there are, the harder the scheme becomes to implement, administer and manage. Keeping it simple by implementing the solution through payroll, having an application process to access the funds and educating employees on how the solution works (and how it can work for them) will make it easier to rely on the default-or-nudge approach to limit access to funds.
The significant advantage of setting up this double-barrelled approach to savings through an employee benefits platform is that it can be structured in a way that would be most effective.
Which brings us to the question of what savings vehicle should be used …
Types of savings vehicles
There are various savings vehicles that could be used for an emergency savings plan:
- unit trusts
- tax-free savings accounts
- banking accounts
- money market funds
Here’s what to consider when deciding which investment vehicle should be used:
- Financial Intelligence Centre Act (FICA) sign-up requirements: These will most likely apply to each of the above options and could be simplified by processing the solution through payroll.
- Ongoing ease of use: Employees need easy access to view their savings balances. All options meet this requirement, but different financial services companies will have different service offerings.
- Tax implications: In general, the tax-free savings account has a different tax treatment from the other options. For tax efficiencies, a tiered approach to the various savings products may be necessary, although this complicates the overall solution. (See Table 4.4.3 later below for more details on the tax implications.)
Tax-free savings or unit trusts?
Tax-free savings accounts and unit trusts have advantages and disadvantages when compared to the transactional accounts listed.
The tax-free savings account does offer some benefits in the medium term. As there are savings funds left over at retirement in our example, the tax-free savings account worked.
The original intention was for tax-free savings accounts to be used as medium-term discretionary savings to supplement retirement savings.
Contributions are capped at R33 000 a year and R500 000 overall. If money is withdrawn from the account and these limits have been reached, the withdrawn amount can’t be replaced – in other words, you can’t ‘top up’ the tax-free savings account. The risk here is that because there’s no top-up option, people may deplete their tax-free savings allowance over time. In addition, any contributions over R33 000 a year will be taxed at 40%.
Tax-free savings accounts are perhaps better suited to saving for medium-term to long-term financial goals, such as funding a child’s tertiary education.
Unit trusts outside tax-free savings accounts do not attract any special tax benefit. Any interest and growth earned in a unit trust attracts income tax, dividends tax and capital gains tax. Interest and growth earned within a tax-free savings account is not subject to these taxes.
Employees could also be given a shortlist of emergency savings plan options, although this does complicate the scheme and create administrative hassles in showing a combined picture. In our view, selecting a single option works best.
Administration and management
- Employment contracts: Contracts may need to be amended for existing and new employees to take the new savings plan into account.
- Payroll deductions: Is there an option to deduct contributions through payroll and pay them directly to the service provider? Not all products or service providers may offer this.
- HR and payroll support: Even if the contributions are facilitated through payroll deductions, the account will be in the employee’s name and they will have direct access to the service provider. It’s important to know how the service provider will deal with product queries from employees.
- Marketing and communication of the emergency savings plan as a joint solution with the retirement fund: It’s important to have service provider support in this step to encourage take-up of the emergency savings plan.
Tax implications
Employers will need to know the tax implications of introducing an emergency savings plan which works with the retirement fund, as this can have financial implications for employees. Redirecting contributions to an emergency savings plan results in slightly more tax paid each month, which in turn reduces takehome pay (assuming all else remains constant).
The reason for this is that contributions to a retirement fund are tax-deductible up to the 27.5% and R350 000 limits. Those deductions won’t apply to the portion of the retirement contribution that’s redirected to an emergency savings vehicle, as this amount is paid from the employee’s after-tax pay.
Unlike cash payments from retirement funds, there’s no tax on withdrawals from the emergency savings vehicle (if it is a tax-free savings account or transactional account).
It’s therefore important for employees to be able to opt out of the emergency savings plan in favour of managing their tax efficiently.
There are three types of tax that apply when investing: income tax on interest, dividends tax and capital gains tax.5 These apply differently to the
various types of investment vehicles that can be used as an emergency savings plan, as we see in Table 4.4.3.
