Introduction
This is a timely and much needed conversation considering the financial restraints and the negative economic effects that have resulted, and will continue to result, from the COVID-19 pandemic. I don’t deny that financial challenges have always existed. However, the current ones are more adverse, more complicated, mostly unforeseen and largely unprecedented.
The pandemic has resulted to: movement being restricted; lock downs and curfews being put in place; people working from home; schools being closed; and social gatherings being restricted. Globally, some of the economic impacts of these measures are: huge falls in financial markets; closure of businesses; filing for bankruptcy and insolvency by companies; crashing of oil prices; disrupted supply chains; reduced diaspora remittance; risk of recession; surges in unemployment cases; and increase in credit applications.
Governments, in an attempt to shield their countries economically, have come up with and continue to come up with relief packages. Our Kenyan government, in particular, has tried to be proactive in putting in place fiscal and monetary measures to cushion Kenyans against the economic effects of COVID-19. The measures include: supporting the poor and vulnerable families; tax and credit relief; and lowering of VAT and Corporate tax. To this effect, the Tax Laws (Amendment) Act, 2020, the Value Added Tax (Amendment of the Rate of Tax) Order, 2020 and the Public Finance Management (COVID-19 Emergency Response Fund) Regulations, 2020 were enacted.
In speaking of the defects of the above mentioned reliefs by our government, I profess a high appreciation for its effort. Having said that, I proceed to enumerate some of the defects. Firstly, with respect to the monies set aside for the poor and vulnerable, the specifics particularly to whom, when and how the same will be apportioned remain unclear.
Secondly, unlike in the western nations where governments have set aside trillions of dollars and billions of euros to bail out their economies for business closures, job losses among others, Kenya seems to lack such a plan. This is therefore a wake up call for us to have measures in place to address economic difficulties arising from future pandemics similar to COVID-19. As such, it is upon our human ingenuity to come up with and consider more relief options available to us in such circumstances.
In this commentary, I will be exploring tapping retirement benefits as a relief option for the current pandemic and similar pandemics in the future. I will start by looking at the existing laws governing withdrawal of retirement benefits. In the next part I will highlight relevant provisions from The CARES Act (an Act by the US Congress) regarding early withdrawal of retirement benefits. I will then give the relevance of The CARES Act in the Kenyan situation.
Thereafter, I will conclude by proposing that as an economic relief measure for COVID-19 and similar pandemics, the law be amended to: (a) allow employees withdraw a portion of their retirement benefits; and (b) waive the punitive tax liability attached to early withdrawal of retirement benefits. Further, that a subsidiary legislation to that effect be enacted. These measures will be temporary, remaining in force only during the subsistence of such a pandemic.
Laws Governing Withdrawal of Retirement Benefits in Kenya
The Constitution of Kenya under Article 43 (1) (e) guarantees the right to social security. Social security exists to provide monetary assistance for people with inadequate or no income thus it covers retirement benefits (pension). Loosely defined, retirement benefit is compensation in the future for work performed by employees and may contain some portion contributed by employees with a contribution from the employer.
There are four types of pension plans in Kenya: public service pension funds; occupational pension schemes; individual pension plans; and umbrella schemes. These pension plans can either take the form of a defined contribution plan or a defined benefits plan. (I intentionally refrain from going into details regarding these retirement plans and instead focus on the specific aspects of the commentary).
Rule 4 (j) of the Income Tax (Retirement Benefits) Rules, 1994 provides that the payment of pension shall not commence until the employee attains the age of fifty years; or upon earlier retirement on account of infirmity of mind or body. Hence, the tax liability incurred by a member who is withdrawing from a scheme before attaining 50 years or has less than 15 years of pensionable service is more penal compared to that incurred by a member who has attained the age of 50 or who has more than 15 years of pensionable service in the scheme .
The respective tax liabilities are provided under Section 8(5) of the Income Act, CAP. 470 as read with para. 5(d)(i) and para. 5(d)(ii) of the Third Schedule. Worth noting, the government in the Tax Laws (Amendment) Act, 2020 has revised these tax bands and reduced the marginal rate tax bands for pension withdrawals from 30% to 25%. This is in an attempt to increase the disposable income available to pensioners during this COVID-19 period. However, despite the said revision, the tax liability for early withdrawals is still higher than that of withdrawing after the retirement age. Further, in 2019, The Retirement Benefits (Occupational Retirement Benefits Schemes) (Amendment) Regulations, 2019 were enacted to scrap the provision that initially allowed employees to withdraw up to half of pension contributions by their employers before they attained retirement age.
From the foregoing, a fair conclusion can be drawn that the current laws, as they are, are punitive when it comes to early withdrawal of retirement benefits. Mainly because it is the government’s way of deterring people from unnecessarily withdrawing from their pensions schemes before they attain the retirement age. Therefore, to allow access to a portion of one’s retirement benefits without attracting a punitive tax liability during a pandemic like the current one, we will need to effect a legal framework. I now proceed to highlight relevant provisions from The CARES Act (an Act by the US Congress) regarding early withdrawal of retirement benefits that we could borrow from.
The CARES Act
The Coronavirus Aid, Relief, and Economic Security Act (The CARES Act) was passed by the US Congress to help Americans cope with the unprecedented financial fallout from the COVID- 19 outbreak. Of particular importance are the provisions on early withdrawal of funds saved in certain tax-advantaged retirement accounts. The temporary changes eliminate tax penalties on certain early withdrawals.
The legislation restricts relief to qualified participants with a valid COVID-19 related reason for early access to retirement funds. These include: being diagnosed with COVID-19; having a spouse or dependent diagnosed with COVID-19; experiencing a layoff, furlough, reduction in hours, or inability to work due to COVID-19; or lack of childcare because of COVID-19.
It is worth noting that the early retirement benefits withdrawal rules are merely permissive as the CARES Act does not require employers to follow the same. This means, even if one meets one or more of the above stated eligibility requirements, it does not necessarily mean they will be able to access money in their workplace retirement accounts. Therefore, adoption of the provisions are entirely within the purview of the retirement plan.
The CARES Act sets a withdrawal limit that allows eligible participants in certain tax advantaged retirement plans to take an early distribution of up to $100,000 during the calendar year 2020 without paying the 10% penalty tax imposed by the law on most retirement account withdrawals before an account owner is 59 ½ years. The $100,000 being the total, per person, no matter how many retirement accounts one has. It also suspends the mandatory 20% tax withholding requirement that applies to early distributions from an employer-sponsored retirement plan or other workplace retirement plan.
The CARES Act provides two options on how to manage the resulting tax liability following the suspension of withholding tax. One can choose to spread the taxes owed over three years or pay it all in 2020 if one’s income is much lower this year. Alternatively, the Act gives one up to three years to redeposit the withdrawn money into a retirement account. If one restores the retirement funds within three years, they won’t owe tax until they take distributions in retirement.
Relevance of The CARES Act to the Kenyan Situation
On 25th March 2020, the President addressed the nation on the State’s interventions to cushion Kenyans against economic effects of the COVID-19 pandemic. However, as I had earlier noted, the government seems to lack a bigger plan to protect the Kenyans from unforeseen financial hardships. Thus, the current fiscal and monetary policies by the government to deal with the economic effects of COVID-19 may only be good enough for now. Kenyans need more assurance that in case such a pandemic happens again in the future, they will be financially protected.
The COVID-19 pandemic is not the first and neither will it be the last pandemic of its kind. Accordingly, it is necessary to explore any and all possible avenues that will guarantee Kenyans financial empowerment in case of similar pandemics. The CARES Act addresses various issues regarding early withdrawal of retirement benefits as a way of cushioning American workers and their families from financial difficulties during this COVID-19 period. We could borrow some aspects of those provisions but expand the scope to not only apply to COVID-19 but also apply to other similar pandemics.
Conclusion
I appreciate that the government, in the Tax Laws (Amendment) Act, 2020, has attempted to revise the tax bands and reduced the marginal rate tax bands for pension withdrawals from 30% to 25%. However, I feel more should be done in terms of the tax liability because early withdrawal of retirement benefits even with the revision of the rates is still more punitive compared to withdrawing after the retirement age. We ought to shift from the traditional approach of viewing contributions to retirement benefit funds as a means of saving for retirement only, to viewing the same as a day to day mode of saving akin to saving in banks. This expansive view will go a long way in helping employees access part of their retirement benefits and direct the same towards home ownership at an early age as well as navigating through unforeseen financial hardships, among other needs.
It is in view of above that I propose that the relevant retirement benefits laws be amended to address employees’ financial difficulties during pandemics that affect the normal functioning of our daily lives, such as the one we are currently experiencing. The amendment should allow one access a portion of his/her retirement benefits without being subjected to the punitive tax liability attached to withdrawing retirement benefits before the retirement age.
The subsidiary legislation to that effect would inter alia: describe the eligibility criteria; set a withdrawal limit; and address any other issue connected thereto. If the amount withdrawn is within the set limit, no tax liability should be attached however withdrawal of any amount above the set limit should attach tax liability. Express provisions anchored in law will ensure people do not unnecessarily withdraw from their retirement benefits without valid and pressing reasons. Unnecessary and disorderly early withdrawals will result to crashing of the retirement benefits system.
Further, I propose that the provisions be of a mandatory nature rather than a permissive one, unlike The CARES Act where the provisions are permissive. This is because if they are merely permissive, retirement schemes will have the discretion to allow or decline tapping of retirement benefits. The resulting effect of this is discrimination on the basis of what retirement scheme one belongs to. Employees belonging to a retirement scheme that does not allow early tapping of retirement benefits will not receive equal protection under the law. Therefore, retirement schemes will be required to revise their rules to accommodate the above mentioned provisions.
Unfortunately, this will only benefit a section of Kenyans i.e persons under a pensionable employment. Notwithstanding the limitation, I resolve, albeit reluctantly, that withdrawal of a portion of one’s retirement benefits is a relief option worth considering. I say albeit reluctantly because I believe tapping your retirement benefits should be your last option. If you have other financial options, then you may want to consider them and avoid accessing your retirement benefits. However, if this is your only option, then the proposed amendments could help you access your retirement benefits less tax liability to survive through a financial hardship during the subsistence of COVID- 19 and similar pandemics.
HusLaw 