Law to clarify how your retirement fund benefits will be taxed

Major changes to the taxation of retirement fund benefits have taken place over the past three years. Proposals in this regard in the Taxation Laws Amendment Bills this year largely refine the changes that were announced previously or correct anomalies that have arisen as a result.

Retrenchment tax concessions merged
There may soon be greater tax relief for people who are retrenched and receive severance pay, but whatever tax concessions you enjoy at retrenchment will reduce the concessions to which you are entitled at retirement.

Currently, if you are retrenched, you are entitled to receive tax-free the first R30 000 of any lump sum severance package paid to you by your employer. The balance of the lump sum is taxed at the higher of your average rate of tax in the current or previous tax year.

Over the past three years, the taxation of retirement fund lump sums has been reformed, and last year the tax laws were amended to allow you to withdraw up to R300 000 from your retirement fund tax-free on retrenchment. Lump sums greater than that amount are taxed at the favourable tax rates that apply to lump sums withdrawn at retirement. (These rates are favourable because they are better than your marginal tax rate at that level of income.)

The National Treasury is now proposing that you should be taxed the same way, whether you receive a lump sum severance package or you withdraw money from your retirement fund to support yourself after you have been retrenched.

It is proposing that you be allowed to enjoy a tax-free lump sum of up to R300 000 on retrenchment, as well as the favourable tax rates on amounts that exceed R300 000, regardless of whether you receive a severance package from your employer or you withdraw a lump sum from your retirement fund, or both.

However, the tax concessions will be available to you only once in your lifetime. This means that whatever benefit you make use of on retrenchment, be it a tax-free amount and/or a favourable tax rate, only the remaining balance of these benefits, if there is any, will be available on retirement. When the lump sums you have withdrawn exceed the amounts to which the favourable rates apply, you will pay tax on any further amounts at a flat rate of 36 percent.

The National Treasury says its proposals will effectively phase out the tax-free R30 000 you enjoy on a retrenchment severance payout. The provisions that will apply to retrenchment severance payouts will also apply to severance pay for age, sickness, accident, injury or mental incapacity.

Should the proposal be adopted into law, the effective date will be March 1 next year.

Tax-free transfers from an umbrella fund
If your employer withdraws from an umbrella fund, you may in future be able to transfer your retirement savings from the umbrella fund to a preservation fund tax-free.

Umbrella funds are typically offered by retirement fund administrators as a cheaper option for smaller employers that want to offer their employees a retirement fund. A number of employers participate in the same fund.

However, when smaller employers run into financial difficulty, they may stop paying contributions to the fund and eventually cease to participate in it.

When an employer leaves an umbrella fund, it is known as a partial wind-up, because the fund continues for the benefit of the other employers that participate in it. When an employer leaves a fund, the affected employees can:
• Have their benefits paid to them in cash, but they will have to pay tax on the withdrawal; or
• Transfer their benefits tax-free to a retirement annuity fund.

Should the employer set up a new fund, employees can also transfer their benefits tax-free to this fund, but usually this is not an option, because the employer is in financial difficulty. Employees in this situation are currently prevented from transferring their benefits to a pension preservation or provident preservation fund, because the definitions of these funds only allow them to receive amounts that result from the full wind-up of a fund and not from a partial wind-up.

The National Treasury is proposing that the Income Tax Act be amended so that pension preservation funds and provident preservation funds are expressly allowed to receive payments or transfers of benefits following a partial wind-up. It is proposing that the amended law apply to all such transfers of retirement benefits from March 1 next year.

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