Steinberg Inc

Tax payable on your retirement lump sum.

In last month’s issue of Tax Breaks, we dealt with the tax treatment of retirement lump sums when one resigns or is dismissed (prior to reaching normal retirement age). However, when you actually retire from a retirement fund, the rules are a bit different – and SARS gives you a bit more of a break.

Definition of retirement

In the ‘good old days,’ retirement meant that you had reached a certain stage where you stopped working, had a shindig at which you were presented with your gold watch, went on pension, and spent the rest of your days trying (unsuccessfully) to perfect your golf swing. However, everyday words always seem to mean something different when it comes to tax, and the concept of retirement is no different.

From a tax point of view, the term ‘retirement’ refers not to the time when you decide (or circumstances force you) to stop working, but rather the event that triggers your retirement from a retirement benefit fund. The difference between ‘retirement’ and ‘withdrawal’ is that should you elect to receive your entire fund or part thereof as a lump sum, such lump sum is taxed at more favourable rates if your exit from the fund qualifies as a retirement.

You can therefore ‘retire’ from a fund in the following circumstances:

• Any time from your 55th birthday onwards; or
• At any age, provided that such retirement is due to disability or ill-health. In most cases you will only be entitled to retire if such disability or ill-health is of a permanent or long-term nature.

Note that retiring doesn’t mean that you will never be entitled to work again. With modern healthcare and more active lifestyles, many people are being retained as consultants—or even starting completely new careers.

Even in the case of ill-health or disability retirements, there are many cases where the person’s disability or health status nonetheless enables them to work in areas that are less physically strenuous than the job from which they were medically boarded.

Taxation of lump-sum benefits upon retirement

Using similar scenarios as in last month’s article, except for the fact that the person has retired rather than withdrawn from their fund, the tax calculation is as per the table below.

Transfer of benefits to another retirement fund

If you have reached retirement age but you plan to continue working, you need to have both a tax consultant and an investment advisor run the numbers for you, especially if you don’t need to start drawing a pension immediately.

Depending on your personal circumstances and tax position, it may be more advantageous for you to withdraw from your employer’s fund and transfer the benefits to another fund, or consider making your fund “paid up” (provided that the rules allow for this) rather than to take a retirement benefit.

However, make sure that you take all of the possible implications into account, especially if you are entitled to receive certain post-retirement benefits (such as subsidised medical aid or the enjoyment of staff discount benefits that may be extended to retired employees as well).

The last thing you want is to resign rather than retire in order to save a little bit of tax, but then end up with no post-retirement medical cover!

Pensions / annuities

In the case of your retirement from a pension or retirement annuity fund, your lump sum is usually limited to one-third of the total amount invested. The balance must be utilised to purchase an annuity (pension).

Such annuity is fully taxable, just like your salary used to be (except that you no longer have a car allowance or other tax-preferential perks). This is different to voluntary purchase annuities, where part of the annuity represents the return of capital (with only the income portion therefore subject to tax).

Lump sums received upon retrenchment

With effect from 1 March 2011, severance benefits received will be treated on the same basis as a retirement lump sum, thus qualifying for the preferential tax treatment.

However, if you are retrenched prior to your 55th birthday, you will not be able to retire from your retirement fund—which means that any lump sums paid out from your retirement fund will still be treated as a withdrawal (unless your severance has been for reasons of ill-health, in which case the normal retirement lump sum tax tables are applicable).

In practice, your employer and your retirement fund are separate legal entities, and you should therefore be receiving two IRP5 certificates.

The biggest tax risk is that since (for example) your employer’s payroll department will be dealing with your severance, while a fund manager could be handling the retirement fund, it’s possible that either (or both) entities might not know the full circumstances of your severance, and end up putting the wrong lump sum codes on the directive application.

It is therefore critical that you receive appropriate tax advice once you have received notification of your severance package and available retirement fund lump sum, but before any tax directives are applied for.

Once the directive has been and the IRP5 certificates have been issued, rectifying any errors is both difficult and time-consuming—in the case of one of my own clients, it took two years to sort things out with the employer and get the excess tax refunded by SARS.

Receipt of previous retirement benefits

The tax tables applicable to retirement fund lump sums received upon retirement are ‘once-in-a-lifetime’ scales.
As will be seen more clearly from the calculation example above, this means that while a first-time taxable retirement lump sum of R500 000 would be exempt from tax, a subsequent lump sum of R200 000 would be subject to tax at 18%, being the rate applicable to the next band.

Written by STEVEN JONES

This article is a general information sheet and should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted. (E&OE)

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