Lump sum Withdrawals

Taxation of lump sum withdrawals from retirement funds

The two Taxation Laws Amendment Acts passed by Parliament on 30 September 2009 finally settled the confusion in the retirement industry as to how lump sum withdrawals paid by a retirement fund when a person withdraws prematurely from the fund has been clarified. Such withdrawals usually occur when a person changes jobs, and membership of the ex-employer’s pension or provident funds is therefore terminated.

There has been great confusion about the taxation of such lump sums and the date from which these rates are applicable, which has now been cleared. Note that these rates apply to lump sums paid. If, instead of taking a lump sum, the whole amount due from the old fund is transferred into a new fund, no tax is payable.

The rates of tax applicable to both lump sum withdrawals on genuine retirement and on premature withdrawals are set out below in a single table, so that their similarity can be appreciated. The only difference is in the initial tax free amount. For pre-retirement lump sums, the tax free amount is R22 500, and for lump sums paid on retirement, the tax free amount is R300 000.

The tax rates are as follows:

These rates are applied to the cumulative lump sums received from 1 October 2007 in the case of lump sums on retirement, and from 1 March 2009 in the case of pre-retirement lump sums. Any lump sums received prior to those dates are ignored.

The explanatory memorandum to the Acts gives the following example to illustrate the cumulative principle.

A person resigns from a pension fund and receives a pre-retirement lump sum of R250 000. She later resigns from a second pension fund and receives another pre-retirement lump sum of R350 000. When she finally retires, she receives a retirement lump sum of R100 000. Applying the above tax tables –

It is apparent from this example that no record needs to be kept of the actual taxthat was paid on previous lump sums – one just calculates the tax thatis now payable on the latest lump sum. The effect of this is that pre-retirement lump sums are penalised only to the extent that the amount between R22 500 and R300 000 is taxed at 18%, whereas if those lump sums had been paid on retirement they would have been free of tax.

There is a further slight twist to the above in the case of retrenched workers. Any lump sums paid by a retirement fund to a person who was retrenched on or after 1 March 2009 will be taxed as though they were paid on retirement, and not as pre-retirement withdrawals. In other words, the first R300 000 of the lump sum will be tax free, and not just the first R22 500. This will serve to soften the retrenchment blow.

As from 1 March 2009, an award of a share of a spouse’s interest in a retirement fund made to the non-member spouse will be taxable in the hands of the receiving spouse. Previously, the tax had to be paid by member spouse, although they were entitled to recover the tax paid from the receiving spouse.

If the receiving spouse transfers the full amount to another retirement fund, or leaves it in the same fund, there will be no tax payable.

If an amount is taken in cash, it will be taxed as a pre-retirement withdrawal at the rates set out above.

Any amount awarded to an ex-spouse from a retirement fund in terms of an order of divorce that is “of a recurrent nature” is now included in the definition of remuneration in the Fourth Schedule to the Income Tax Act, and is therefore subject to the deduction of employees’ tax.

Such amounts will therefore be taxed at the tax rates applicable to normal salary income.