Determining the tax consequences in respect of any lump sum benefits from retirement funds can be complex and various legislative changes have been incorporated over the last few years, to regulate and align the tax treatment of these benefits.

Lump sum benefits are included in “gross income” in terms of paragraph (e) of the definition in section 1 of the Income Tax Act[1], read with the provisions of the Second Schedule to the Income Tax Act.

The portion of your retirement interest that can be taken as a lump sum depends on the type of retirement fund and whether you withdraw (prior to retirement)[2] or retire (normally after reaching normal retirement age and on leaving your employer) from the fund.

When retiring as a member of a pension fund, pension preservation fund or retirement annuity fund, members are only allowed to take (or commute) a lump sum equal to a maximum of one-third of the retirement interest in that fund. The balance must be used to buy an annuity. This rule does not apply if the entire value of the fund does not exceed R247,500. In these cases, the member may take the full retirement interest as a lump sum. There is no such annuitisation requirement for provident or provident preservation funds, and the member’s full retirement interest in such funds will be paid as a lump sum upon retirement.[3]

The abovementioned lump sum benefits are taxed according to a retirement lump sum tax table.[4] Please note that all lump sums from retirement funds are taxed on a cumulative basis and therefore all lump sums received by the member after 1 October 2007 (i.e. including benefits taken prior to retirement) will be considered in determining the current benefit. Furthermore, contributions to these retirement funds may be deductible, and subject to certain limitations.

Following retirement, it is important to note that two-thirds of the retirement interest in respect of pension, pension preservation or retirement annuity that is received in the form of an annuity, will be taxed in the retiree’s hands to the extent that his or her total income exceeds the tax threshold. Even though the person is retired and no longer earning a salary, he or she may still be liable for income tax on their annuity income.

The take away is that careful consideration should be given to the tax consequences which may arise when retiring from a retirement fund.

[1] No. 58 of 1962

[2] Please note that different rules may apply in respect of such withdrawals and should be considered separately from the circumstances discussed above.

[3] Specific fund rules may however provide for the payment of an annuity.

[4] See SARS’ website for the tax table.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)