Retirement Fund Withdrawal July 4-5, 2009

Easier Calculations, Less Tax to Pay. What's Wrong with That?

As of 2009, does your retirement fund withdrawal now involve an easier tax calculation and a larger amount tax-free? YES.

Does that mean you should withdraw on resignation? Maybe... not.

Certainly there have been a number of recent, beneficial changes to the taxation of lump sums from retirement funds on withdrawal (arising from resignation) and retirement.

Most of the attention has been focused on the simplified tax calculations and the increased tax-free amount of R300,000 on retirement. This is understandable, but many investors are missing an important point.

Retirement fund withdrawal can cause unintended negative consequences for your future

Negative consequences such as destruction of your precious retirement capital. Here's why.

The most important financial consideration when changing jobs is that of preserving retirement savings.

The best way to preserve retirement savings

A pension or provident fund value can be transferred tax-free into a preservation or retirement annuity upon resignation. This allows your savings to grow (there is no tax in investment income and no capital gains tax) and ensures that the funds are ultimately as you intended - for retirement income.

But what about the new tax laws?

Ah! The seductive new 2009 tax laws...

The new tax laws make retirement fund withdrawal seem quite attractive, particularly for a high earner.

Previously, lump sum withdrawals were taxed at a member's highest average rate of tax over the last two years and there was a nominal tax-free amount of R1,800.

Now, the first R22,500 of a retirement fund withdrawal is tax-free and the next R577,500 will be taxed at a flat rate of 18%.

So, if (for example) you have an average tax rate of 35% and a retirement fund of R500,000, you might be tempted to cash in your retirement fund on resignation.

However, all too often and especially in the current tough economic environment, the temptation of using the investment is too much for many people.

They spend it. And it NEVER gets recouped.

And that's not the worst of it

Yes, it gets worse. The real sting in the tail is that any withdrawal taken upon resignation will reduce the tax-free portion of any lump sum taken later in retirement.

The tax-free lumpsum amount of R300,000 allowed on retirement will be reduced by the previous withdrawal amounts.

If the previous withdrawals were large, then the top flat rate of 36% on retirement lump sums will be reached sooner than anticipated, resulting in extra tax liabilities.

And what is the consequence of those extra tax liabilities?

The extra tax payable on retirement as a result of previous withdrawals could result in liquidity problems.

Typically, lump sums taken are used to reduce remaining debt which in turn reduces monthly income requirements in retirement.

In most cases one-third of a retirement fund can be taken as a lump sum, with the remainder being used to provide the retiree with a monthly annuity income.

It's yet another compelling reason not to use your retirement savings as a bankroll when you are between jobs.

How can you free up non-retirement cashflow until the next pay cheque arrives?

It’s a good idea to have an accessible cash investment on hand for emergency purposes.

Money market investments or short-term fixed deposits are ideal.

It is possible to invest a small monthly amount into a Money Market over a period of time.

No accessible cash - what now?

As a general rule, try and redeem your most conservative investments first.

If an accessible cash investment is not available, you might have to redeem funds from your unit trust or endowment investments.

If you have old life or endowment policies, it is worth establishing whether it is possible to take an interest-free loan or part surrender on the policy. Such a loan or withdrawal should not materially affect any risk cover (life and disability) that may be in place on the policy.

If you do not have investments to cash in, then you may want to consider accessing funds from your bond, if possible. This would not be a good long-term option of course, but if you are only going to be between jobs for a few months, then it should be preferable to cashing in retirement funds.

Retirement fund withdrawal is the last resort

If possible avoid retirement fund withdrawals at all costs. It may add value to get impartial, written advice by engaging an independent, fee-based Certified Financial Planner. Such advice should also encompass scenario planning that illustrate the effects of various alternatives on your specific overall retirement plan.

If you do not have a Certified Financial Planner® professional, visit the website of the Financial Planning Institute on www.fpi.co.za to select one.

Ian Beere, CA(SA) CFP® was the financial planner of the year in 2007.
His business partner Debbie Netto-Jonker CFP® founded Netto Financial Services and was financial planner of the year in 2001.

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