29th of July 2010
Taxing early withdrawals
Taxing early withdrawals
In this article, Michael Summerton and Carla Rossouw provide an overview of how withdrawal and retirement benefits are taxed. They use practical examples to show how this tax is calculated. They illustrate how you can save tax by deferring your withdrawal until retirement. They also look at the tax relief Treasury provides on benefits received when a retirement fund member is retrenched…
Regular readers of our commentary will know that we encourage a long-term approach to investing. We especially encourage investors not to be tempted to dip into their retirement savings. Withdrawing funds from your retirement savings before you retire not only reduces the tax-free amount available to you when you retire, but also causes the benefit that you take at retirement to be taxed at a higher rate. Therefore, by deferring withdrawals until you retire, you may reduce your total tax bill.
Making sense of your potential tax bill
There are two main categories of benefits that retirement funds pay members:
-
Withdrawal benefits: Payable before retirement (for example, if you resign or get divorced).
-
Retirement benefits: Payable when you retire from the fund or upon your death.
Before 1 October 2007, the tax on retirement and withdrawal benefits received from retirement funds (including pension, provident and retirement annuity funds) was determined by a complex ratings formula. This formula was simplified from 1 October 2007, with further changes coming into effect on 1 March 2009.
In terms of the latest provisions, your tax liability for retirement and withdrawal benefits is determined by "special rate" tables.
If you are a member of a retirement fund, you do not pay tax on the first R300 000 when you retire from the fund, or upon your death. However, if you withdraw cash before you retire only the first R22 500 is tax free. In both instances, the tax free amount is a "once-in-a-lifetime" concession.
The "special rate" tables take into account all withdrawal and retirement benefits you received or accrued on or after 1 October 2007. In other words, all the benefits you received on or after 1 October 2007 are added together to calculate how much tax you owe when you withdraw or retire from your retirement fund.
Tax on withdrawal benefits
From 1 March 2009, all withdrawal benefits from a retirement fund are taxed according to the withdrawal benefit table:
-
R0 - R22 500: 0 percent
-
R22 501 - R600 000: R0 plus 18 percent of taxable income exceeding R22 500
-
R600 001 - R900 000: R103 950 plus 27 percent of taxable income exceeding R600 000
-
R900 001 and above: R184 950 plus 36 percent of taxable income exceeding R900 000
Example one
Mr A is a member of two pension funds. He resigns from his employer and decides to withdraw from one of his funds (as opposed to preserving his savings until retirement). Mr A receives a R250 000 withdrawal benefit from the fund. The tax he has to pay on the R250 000 is calculated as follows:
-
Step one: Apply the withdrawal benefit table above to the withdrawal amount. Calculation: R0 + 18 percent x (R250 000 – R22 500) Tax payable: R40 950
Mr A need not pay any tax on the first R22 500 of the R250 000. The remaining R227 500 is taxed at a rate of 18 percent. Based on the above calculation, he must pay an amount of R40 950 on his withdrawal benefit.
Example two
Mr A subsequently decides to withdraw R350 000 from his second pension fund. Using the withdrawal benefit table, the tax that he must pay on the subsequent R350 000 withdrawal benefit is calculated as follows:
-
Step one: Add up the withdrawal benefits received. Calculation: R250 000 + R350 000. Total withdrawal benefits: R600 000
-
Step two: Apply the withdrawal benefit table to the full amount. Calculation: R0 + 18 percent x (R600 000 – R22 500). Tax payable: R103 950
-
Step three: Subtract the tax Mr A had to pay on all withdrawal benefits he received prior to the withdrawal benefit of R350 000. We have already calculated this in example one as being R40 950. Calculation: R103 950 – R40 950. Total tax payable: R63 000
Mr A must therefore pay a total of R63 000 in tax for his second withdrawal benefit.
Tax on retirement benefits
Retirement benefits are taxed according to the rates shown below:
-
R0 - R300 000: 0 percent
-
R300 001 - R600 000: R0 plus 18 percent of taxable income exceeding R300 000
-
R600 001 - R900 000: R54 000 plus 27 percent taxable income exceeding R600 000
-
R900 001 and above: R135 000 plus 36 percent of taxable income exceeding R900 000
You do not have to pay tax on the first R300 000 of your retirement benefit. As stated earlier, this is a once-off concession. This means that while your first-time retirement benefit of R300 000 is exempt from tax, any subsequent retirement benefits of R300 000 will be taxed at 18 percent, the rate applicable to the next band of the retirement benefit table.
Example three
Mr A now decides to retire from his retirement fund and receives a retirement benefit of R100 000. Taking into account that he has already received two withdrawal benefits (see examples one and two), the tax he must pay on the R100 000 is calculated as follows:
-
Step one: Add up the retirement and withdrawal benefits Mr A received. Calculation: R250 000 + R350 000 + R100 000. Total benefits: R700 000
-
Step two: Apply the retirement benefit rate table (Table two) to the full amount. Calculation: R54 0000 + 27 percent x (R700 000 - R600 000). Calculation: R54 000 + R27 000. Tax payable: R81 000
-
Step three: Add up the withdrawal benefits received before retirement (i.e. from examples one and two) and apply the amount to the retirement benefit table (table two). Calculation: R250 000 + R350 000 Total benefits: R600 000. Calculation: R0 +18 percent x (R600 000 - R300 000). Tax payable: R54 000
-
Step four: To calculate the total tax payable on the retirement benefit of R100 000, subtract the tax payable in step two from the tax payable in step three. Calculation: R81 000 – R54 000. Total tax payable: R27 000
The R54 000 is not the actual tax paid on the previous withdrawal benefits, but rather the amount of tax Mr A would have paid on his withdrawal benefits had he postponed them until his retirement. The difference between the solutions in step two and step three (i.e. R27 000), is the actual tax payable on the R100 000 retirement benefit that Mr A received. If Mr A had deferred his two withdrawals and taken the full R700 000 at retirement he would have saved R49 950 in tax.
Retrenchment
Recent changes to the Income Tax Act (effective from 1 March 2010) mean that if you withdraw from your employer’s retirement fund because you are retrenched, your withdrawal benefit will, in certain circumstances, be taxed in the same way as if you had retired from that fund.
The intention of the amendments is to treat the withdrawal benefit on retrenchment in the same way as a retirement benefit for tax purposes. The R300 000 exemption and aggregation principle apply.
These changes apply only to withdrawal benefits if you are retrenched from an employer retirement fund, and not to any other retrenchment bonuses or gratuities (other payments) your employer pays you. Depending on your circumstances, retrenchment bonuses and gratuities qualify for the R30 000 tax exemption in terms of section 10(1)(x) of the Income Tax Act, with the balance being taxed at your average rate of tax.
RECENT NEWS
19th of March 2010
Good Governance for Retirements Funds
Good Governance for Retirements Funds Read More...
8th of June 2010
Interest rate increase on Housing Loans
Interest rate increase on Housing Loans Dear Sir /Madam Kindly note that the current interest rate of 14% charged to the members for housing loans is not in accordance with the Pension Funds Act, and as a result the fund has been instructed by the Regulator (Financial Service Board) to increase the interest rate from 14% to 15%. Thus with effect from 1 July 2010, the interest rate on all new Housing Loan Applications will be 15% as required by the Pension Funds Read More...
29th of June 2010
Death Benefits Distribution
Death Benefits Distribution There are new challenges facing trustees. A more appropriate and sound way of ensuring that lump sum benefits owed to the minor children of a deceased member of a retirement fund, are properly managed has become necessary, as the number of orphans and child headed households spirals. Caregivers, be they family, friends or strangers need to have access to the death benefits so that they are not financially burdened. But the possibility Read More...
19th of November 2010
IMPORTANT NOTICE TO EMPLOYERS AND EMPLOYEES
IMPORTANT NOTICE TO EMPLOYERS AND EMPLOYEES Read More...
2nd of February 2011
LOCAL NEWS
LOCAL NEWS Directives are NOT final! Why when you withdraw your pension, you pay – and then pay again. PIETERMARITZBURG - When pension or provident fund members resign (or are retrenched) from their employers, they are faced with the decision of whether to transfer their accumulated retirement benefit to a preservation fund or other approved fund, or to take the cash. From a tax point of view, the choices are fairly straightforRead More...
11th of February 2011
Tax Information
DIRECT HOUSING LOANS LEGAL REQUIREMENTS In terms of the Pensions Fund Act, Retirement Funds are allowed to lend money (up to a maximum of 25% of their Assets) to their members for the sole purpose of housing. The minimum rate of interest that can be charged on these loans is prescribed by the Income Tax Act. The Trustees are held liable to ensure that loans are used exclusively for housing, as the loans represent an investment by the Fund. LOAN SCHEME TheRead More...
2nd of March 2011
Proposed Interim Retirement Reforms
Proposed Interim Retirement Reforms Read More...
24th of June 2011
Where has the retirement law gone?
Where has the retirement law gone? Rumours have been floating around the industry that if employer contributions became taxable benefits in employees' hands, as proposed in the February Budget, employers would change their pension fund rules to decrease employer contributions. The reason for that is it would protect employees from a higher fringe benefit. So the absence of draft legislation on SA retirement reform in this week's draft amendment bill mRead More...
11th of August 2011
Sanlam calls for sea change in retirement industry
Benchmark research shows South Africans worse off now than 30 years ago Sanlam Employee Benefits (SEB) today released the results of its 2011 Benchmark survey, a comprehensive annual review of South Africa’s retirement industry. Now in its 31st year, the most recent research has allowed Sanlam to take a retrospective look at retirement in South Africa over the past 30 years. This has revealed that changes made in the 1990s to shift the risk and responsibility of retRead More...
