Delays to lump sum payments of Retirement and Death Benefits due to new taxation legislation

Trevor Manuel mentioned in his budget speech today that a simplified approach to taxing lump-sum payments on retirement was tabled last year. Similar proposals according to the Minister will be made for the taxation of other withdrawals from retirement funds, together with revisions to the various monetary thresholds and percentage contribution limitations. What could this mean in the future?

Last year the taxation of lump sum benefits on retirement and death was simplified, but the taxation of pre-retirement lump sum benefits remained unchanged, taxable at average rates above certain tax-free amounts. Clearly the intention is to simplify the taxation of these withdrawals. While it is not clear what the proposals are, possibilities include a specific tax scale related to the size of the lump sum benefit.

Last year too an appendix was introduced to the Income Tax Act which summarised monetary thresholds relating to various aspects of the Act including limits related tax free lump sum benefits, contribution deductibility, commutation limits and the like. It is possible that some of these may be adjusted for inflation.

The rationalisation of the contribution deductions to the various sorts of tax-approved retirement vehicle may also be on the cards. A single overall deductible percentage irrespective of the nature of the vehicle (pension fund, provident fund or retirement annuity fund) may be desirable in many quarters but whether the change will go that far is not clear.

There is also evident a desire to limit the incentives to the wealthy, so a rand cap to contribution deductions appears to be under consideration.

Background

In his 2007 Budget, Finance Minister Trevor Manuel announced a new simpler method to calculate the tax due on retirement fund lump sums and on death benefits paid out by retirement funds.

The new calculation method became effective on 1October2007. . Prior to 1October2007, the calculation of the tax-free portion of the lump sum amount on a member’s retirement or death, used complex formulas. The formulas required that the period of the retirement fund membership and the average tax rate of the member’s salary over the past five years prior to retirement or death, be taken into account, to calculate the tax-free portion of the lump sum amount.

As from 1 October 2007, the member’s years of fund membership and the average rate of tax of the past five years are no longer necessary to the calculation of the tax-free portion. Instead, the lump sum death and retirement benefits, which accrue on or after 1October2007, will be taxed as follows:

* The first R300 000 (which is a life-time allowance) plus any disallowed contributions and tax-free amounts paid from public funds less any previous tax-free allowances, are tax-free.

* The next R300 000 is taxed at 18%.

* The next R300 000 is taxed at 27%.

* The balance of any lump sum that remains is taxed at 36%.

Under the Income Tax Act, a retirement fund has the duty to hold back any tax due on a retirement fund lump sum and on a death benefit payment and to pay this tax over to SARS on behalf of the member. To do so, the retirement fund has to obtain a tax directive from SARS before it can process any claims from members or their beneficiaries.

The system that SARS uses to issue directives has not yet been upgraded to accommodate the new simpler method of calculation of lump sums due on death or retirement. SARS advised all retirement funds that the expected completion date is the end of November2007. SARS has provided for interim measures to process retirement and death benefits accruing as from 1October2007.

The impact on fund members taking retirement after 1 October 2007:

1. As an administrator, Old Mutual continues to use the electronic tax directives system of SARS for the submission of the relevant forms. While some forms might become obsolete, given the new taxation method, we continue using it until SARS releases new forms. In this way, we hope to avoid delays in obtaining directives for retirement and death benefits due after 1October 2007.

2. SARS then assesses the tax on the post 1October2007 retirement benefits via a manual process. SARS has indicated that it will take longer for it to issue the tax directives, and the turnaround time to issue the directive/ assessment can take up to twoweeks

3. SARS has alerted retirement funds to advise their members retiring on or after 1 October 2007 of this delay in obtaining a tax assessment. As there is already a delay in paying death benefits, due to the requirement of tracing dependants of the deceased member, the impact of this delay should be minimal for such benefit payments.