Ashley Percival, CFP®
Working during our earning years may provide a decent lifestyle, but often will not secure a decent retirement. This is generally due to a lack of discipline and proper financial planning. Whilst there are many ways to save for retirement, e.g. starting a business to sell or building a rental property portfolio to generate annuity income, pension funds[i] make up a large portion of retirement savings.
Unlike in many other countries, members of pension funds in South Africa can access pension benefits before retirement. Unfortunately, many do so without fully understanding the effects these early withdrawals have. Not only is the amount of money available at retirement reduced, there are also severe tax consequences.
Difference in tax treatment of withdrawals before and at retirement.
|Retirement lump sum tax table||Withdrawal lump sum tax table|
|Taxable amount||Tax rate||Taxable amount||Tax rate|
|0 – R500 000||0%||0-R25 000||0%|
|R501 000 – R700 001||18% of each R above R700 000||R25 001 – R660 000||18% of each R above R25 000|
|R701 000 – R1 050 000||R36 000 + 27% of each R above R700 000||R660 001 – R990 000||R114 300 + 27% of each R above R660 000|
|R1 050 001 +||R130 500 + 36% of each R above R1 050 000||R990 001 +||R203 400 + 36% of each R above R990 000|
The following example illustrates the hefty price you pay when making an early withdrawal from a retirement fund.[ii]
John changes jobs in June 2009 and decides to not preserve his pension fund proceeds of R850 000. Instead he cashes in the full amount and has to pay tax as per the withdrawal tax table as follows: R114 300 + 27% of the amount above R660 000 which is R190 000 x 27% = R51 300. Therefore, R114 300 + R51 300 = R165 600.
Some seven years later in 2016, John retires and takes the permitted 1/3 (R500 000) of his pension fund value of R1 500 000 held at his current employer.[iii] John will pay tax as follows:
Step 1: Calculate the tax on the total lump sums taken applying the retirement tax table.
Total lump sum taken = R850 000 (pre-retirement withdrawal) + R500 000 = R1 350 000.
Tax on total lump sum taken is R130 500 + 36% of each Rand above R 1 050 000. R1 350 000 – R1 050 000 = R300 000 x 36% = R108 000. Thus R130 500 + R108 000 = R238 500.
Step 2: Calculate the tax on the previous lump sum taken applying the retirement tax table.
Tax on previous lump sum taken (R850 000). R36 000 + 27% of amount above R700 000. R850 000 – R700 000 = R150 000 x 27% = R40 500. Thus, R36 000 + R40 500 = R76 500.
Step 3: Calculate the tax on the current lump sum taken
Tax on current lump sum taken is tax to be paid on total lump sums less tax that would have been paid on previous lump sum.
R238 500 – R76 500
= R162 000
This means that John paid a total amount of tax of R327 600 (R165 600 pre-retirement and R162 000 at retirement).
What if John did not make a pre-retirement withdrawal and preserved his full fund value of R850 000 when he changed jobs?
Assuming no growth, John’s retirement proceeds would have been R2 350 000 at retirement (R850 000 + R1 500 000). John may withdraw 1/3 (R783 333) of the R2 350 000 at retirement.
Applying the retirement tax table, John will pay tax as follows: R36 000 + 27% of amount above R700 000. R783 333 – R700 000 = R83 333 X 27% = R22 500. Thus, R36 000 + R22 500 = R58 500.
The early withdrawal not only resulted in John paying R269 100 (R327 600 – R58 500) additional tax, he also lost out on years of growth on the money withdrawn.
If you took the time to calculate the price of instant gratification, you might think twice about paying it.[iv]
[i] Includes provident funds [ii] See https://www.youtube.com/watch?v=Dwq5i7ftbTU&feature=youtu.be for different examples. [iii] 2/3 must be used to purchase a pension. [iv] Alfred Edmond, Jnr.