Pension and retirement annuity funds allow you to withdraw up to one third of the value in cash, while provident funds permit you to take the full value in cash - unless you want to invest any part of the money in a pension or annuity. Preservation pension and provident funds are subject to the same rules as ordinary pension and provident funds.
When you withdraw cash from a retirement fund at retirement, it is currently taxed as follows:
- The first R500 000 is tax-free;
- The next R200 000 is taxed at 18 percent;
- Another R350 000 is taxed at 27 percent; and,
- Any more is taxed at 36 percent.
Many people only withdraw the tax-free amount from their retirement fund or funds at retirement. They then invest the rest in an annuity (a pension). This means that no tax is paid on lump sums. They only pay income tax on their pension income.
Say you have taken cash from a retirement fund earlier (before you retire), this is what happens:
The scale shown above shows lifetime limits. So, if you matured a retirement annuity a few years before retiring, and took R250 000 out tax-free, the tax-free amount available to you now is only R250 000.
If you have a pension fund or retirement annuity that has a value at retirement of less than R247 500, you may withdraw the full amount in cash. It is taxed as any other lump sum, according to the scale above.
If you take early retirement as part of a retrenchment, a slightly different set of rules apply. Retrenchment packages normally include a number of parts, which are:
- Notice pay;
- Pro rata share of bonus;
- Outstanding leave pay, if applicable;
- Severance package.
The severance pay is taxed in the same way as a retirement lump sum. This means that if your severance pay is greater than R500 000, there will be no tax-free amount available if you take a cash lump sum when you retire from your retirement fund. The rest of the package will be taxed as income.
For example: If you are given a severance package of say R600 000, and you take another R500 000 from your retirement fund, your lump sum tax will be as follows:
| Severance package | R600 000 | ||
| Tax free amount | R500 000 | ||
| Taxable amount taxed at 18% | R100 000 | R18 000 | |
| After tax Severance amount | R600 000 – R18 000 = R582 000 | ||
| Retirement lump sum | R500 000 | ||
| Tax free | R0 | ||
| Taxable amount | R500 000 | ||
| Taxed at 18% | R100 000 | R18 000 | |
| Subtotal | R400 000 | ||
| Taxed at 27% | R350 000 | R94 500 | |
| Taxed at 36% | R 50 000 | R18 000 | |
| Total tax | R130 500 | ||
| After tax retirement lump sum | R500 000 – R130 500 = R369 500 |
To show the difference between retirement tax and tax on retirement benefits taken before reaching retirement age, take a look at the current table. Minimum retirement age in terms of the Pension Funds Act is 55.
- The first R25 000 is tax-free;
- R25 001 to R660 000 is taxed at 18 percent;
- R660 001 to R990 000 is taxed at 27 percent; and,
- Anything greater than R990 001 is taxed at 36 percent.
There is another aspect of taxation of lump sums at retirement. Tax deductible contributions made by individuals to retirement funds during their working lives are limited to 27.5 percent of the greater of their remuneration or their taxable income. There is an overall limit of R350 000 per annum In terms of S11(k) of the Income Tax Act.
Tax deductible contributions reduce your taxable income, providing a considerable benefit. For example: If you earned R200 000 of income and were taxed on it, you would pay R20 286 in tax for that year. If you contributed 27.5% to a retirement fund, you would contribute R55 000 and would only be taxed on R145 000 - which means you have to pay R10 386 in tax for that year. Your pension contribution in this case would save you R9 900 in tax, which would reduce the net cost of your retirement fund contribution to R55 000 - R9 900 = R45 100. Therefore, it is worthwhile having tax deductible contributions.
If you contribute more than the allowed amount, that extra contribution accumulates until you contribute less or until you retire. At retirement, any retirement fund contribution that was ‘not allowed’ may either increase your tax-free amount, or it may be offset against tax on your pension.
People often forget about retirement annuity contributions that were not allowed. However, SARS keeps track of them. So, it’s well worth enquiring if you have any ‘disallowed contributions’ on record.
If, for example, you find an accumulated amount of R35 000 of these contributions that were not allowed, your tax-free lump sum can either increase from R500 000 to R535 000, or you can deduct the R35 000 from your taxable income in your first year of retirement. This appears in S10C(2) of the Income Tax Act.
D.L. Crawford CFP ®
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