Retirement Funds New Rules -- The Weekender/Business Day -- March/April 2007

Retirement Funds

There is important news for all South Africans who are about to retire as well as those saving for their retirement.

The national treasury has just proposed that from October 1 the maximum tax-free amount of a lump-sum withdrawal from retirement savings vehicles will increase to R300 000 (previously the tax-free amount was approximately R120 000).

The next R300 000 will be taxed at a rate of 18% and a flat rate of 36% will be applied to any lump-sum withdrawal that exceeds R600 000.

For most investors saving for their retirement, this is good news as the tax-free lump sums have been increased, allowing access to even more money at the lowest tax rate.

For investors over the age of 55 who are about to retire with more than R1,8m in a provident, pension or retirement annuity fund, some careful planning is necessary. If you have a carefully planned strategy to withdraw your full retirement benefit at the minimum tax rate, you had better review your retirement planning.

When you retire from a pension, provident or retirement annuity (RA) fund, two calculations are important.

1. First, you need to determine how much of the retirment funds value you want paid to you as cash. When dealing with a retirement annuity or pension fund, you may choose between nil and one-third of the total fund value. In the case of a provident fund, you may opt to take nothing or may take the entire fund value. The balance will be invested in an annuity which will provide you with a monthly pension for life.
2. Second, you need to determine how much of the lump sum will be tax-free and, if taxed, at what rate.

In my view, the answer to the first question depends on the answer to the second question.

My recommendation has been that clients should take any cash benefit that is tax-free. If the amount of any cash benefit is going to be taxed, you should consider this carefully.

Let me illustrate by way of an example. Suppose Mr Smith has an RA fund of R1,8m and has no other retirement fund. Mr Smith's average rate of tax was 30%. Previously it made sense to draw R120 000 of the R600 000 (one-third of the RA fund value) as this was tax-free. If you drew more, it would be taxed at your average tax rate. In Mr Smith's case it would not make sense to lose 30% of the fund value by drawing another R480 000. Under the proposed amendments, your cash lump sum now on offer is R600 000.

However, the tax-free amount will be R300 000 (which you should take). The next R300 000 will then be taxed at 18% instead of your average rate. If your lump sum is more than R600 000, the tax rate will be 36%.

When should you take cash at nil tax? Always!

In most instances you should use this cash to pay off outstanding debts.

When should you take cash at 18% tax? Only when all your retirement capital is in your pension fund and it makes tax and financial sense to lose the 18% in exchange for additional after-tax capital. However, there is research suggesting that allowing capital to be invested in a living annuity as opposed to in a unit trust, after paying the 18% lump-sum tax, will put more in your pocket after tax in the long run.

If you are about to retire from your job with more than R500 000 in retirement capital, you may want to consider deferring your retirement if possible in order to make use of the additional tax-free lump sum.

If you have a provident fund, provident preservation fund or significant other retirement funds and have managed your income over the past three years to be at the 18% average tax level, and were intending to draw the full amount of the benefit at a cost of 18% in tax, you may need to retire before September, as you will be worse off under the proposed new rules.

In the case of a R5m lump sum, you will pay an additional R760 000 in tax. If you cannot retire before September, you may need to seek advice and reconsider the allocation of your pension capital between cash lump sum and annuity.

My advice to you is to consult an independent, fee-based certified financial planner to advise you on the proposed amendments regarding retirement funds.

If you do not have a certified financial planner, visit the website of the Financial Planning Institute on www.fpi.co.za to select one. There is plenty at stake.

Debbie Netto-Jonker, CFP™, is founder of Netto Financial Services and was financial planner of the year in 2001.