Taxation of retirement funds

Prof Peter Surtees, Director, Deneys Reitz Tax Services

The current amendments to the Income Tax Act promulgated in September see the conclusion of the process begun in 2007 of simplifying the taxation of funds withdrawn from retirement funds, whether by resignation, retrenchment or retirement. Earlier amendments had provided certainty as to the treatment of these funds where a marriage terminates and one spouse is a member of a fund. These were followed by changes discussed in this article.

Previously funds withdrawn on resignation from a fund (usually when the member resigned from his or her employment) were fully taxable in the hands of the recipient save for a derisory R1 800, which had remained unchanged in the Act since the days when that amount was meaningful.

Until the amendments, on retirement from a fund the taxable portion of the lump sum paid out would be calculated with reference to two forbiddingly complex formulas in the Second Schedule to the Act and the application of the averaging provision in terms of which, with the use of yet another complex formula, the taxable portion would be taxed at the recipient’s average rate of tax.

This convoluted process can have appealed to no one but sadistic academics setting taxation examination papers and perhaps programmers tasked with designing the systems to enable retirement fund administrators to do the calculations. It has now been replaced with a far simpler system. There are two new stand alone tables, one for resignation and the other for retrenchment or retirement, the only difference being that for resignation the first R22 500 is fully exempt while the exempt amount for retrenchment and retirement is R300 000. After these exempt portions the amount up to R600 000 is taxed at 18%, the next R300 000 at 27% and any amount above that figure at 36%. Because the tables are stand alone, no account is taken of any other income, or any assessed loss or expenses of the taxpayer from other sources.

The tables are accumulative. To determine the level at which a particular lump sum should be taxed, all lump sums previously received are added together, excluding sums received under the previous complex formula driven dispensation.

Any amount received as contemplated above will not be taxed to the extent that it is paid into another retirement fund or a preservation fund, with the caveat that if an amount from a pension fund is transferred to a provident fund it will be taxed. The reason for this exception is that the treatment of pension contributions differs from that of contributions to provident funds.

An example of the application of the tables appears below.

The taxpayer resigns from one of her two employment positions in 2009, is then employed elsewhere but retrenched in 2010. She retires from her second position in 2011. When she resigns, the first R22 500 is exempt and the remaining R227 500 of her R300 000 lump sum is taxed at 18%. When she receives R450 000 on retrenchment, she has access to the R277 500 exempt portion up to R300 000 and R72 500 of the 18% band. The remaining R100 000 is taxed in the 27% band. On her retirement, she uses the balance of R200 000 in the 27% band and the balance of R200 000 is taxed at the maximum rate of 36%.