Issue: June/August 09
Taxation and the cumulative effect of lump sum withdrawal benefits
Legal and Technical: Absa Consultants and Actuaries
With effect from 1 March 2009, the Revenue Laws Amendment Act, 2008, introduced a new method for the taxation of lump sum withdrawal benefits. It is important to look at the total impact that these changes will have on retirement benefits.
Prior to 1 March 2009, lump sum withdrawal benefits from retirement funds were taxed at the member's average rate of tax with the first R1 800 in each tax year being free of tax. Lump sum withdrawal benefits will now be taxed according to a prescribed withdrawal benefit tax table. The tax a member will pay when withdrawing prior to retirement in terms of the tax table proposed in the Draft Taxation Laws Amendment Bill, 2009, is as follows:
It is further proposed that all lump sum benefits received from a retirement fund will be taxed on a cumulative basis. The significant impact of this is that when the member eventually retires, the total value of the lump sum benefits previously received by the member will now be taken into account when calculating the tax payable on the member's retirement.
The effect of the new method of taxation of lump sum benefits is best illustrated by way of examples:
Example 1: If a member withdraws from a fund after 1 March 2009 and receives a lump sum withdrawal benefit of R200 000, the first R22 500 will be taxed at 0% and the balance will be taxed at 18%, resulting in a total tax of R31 950 being payable.
Example 2: if the same member withdraws from another fund a couple of years later and receives a lump sum withdrawal benefit of R500 000o, the tax will be calculated by adding the previously accrued lump sum of R200 000 and the current R500 000 lump sum and then calculating the tax on the combined amount of R700 000.The tax on the R700 000 will be R103 950, plus 27% on the amount above R600 000, which amounts to R130 950.
Then the amount of tax on the previous lump sums must also be calculated, using the same table. The tax on the previous lump sum of R200 000 will be calculated at 18% on the amount above R22 500, which amounts to R31 950.To calculate the tax payable on the R500 000, the tax on the total lump sum is deducted from the tax calculated in respect of the previously accrued lump sums. Thus, tax payable is R130 950 less R31 950 = R99 000.
Example 3: If the same member retires a couple of years later and elects to take R300 000 as a cash lump sum, the taxable amount will be calculated as follows, using the retirement tax table below:
To calculate the tax payable on the lump sum retirement benefit, all the previously accrued lump sum benefits must be added together, that is, the R700 000 (Example 1, R200 000 and Example 2, R500 000) lump sum withdrawal benefits taken previously and the R300 000 lump sum retirement benefit taken now. Tax on the total R1 m will be calculated as follows: R135 000 plus 36% on R100 000 = R171 000.
The tax on the previously accrued lump sums must then be calculated according to the above retirement tax table, that is, 27% on R100 000 plus R54 000 = R81 000. The tax payable on the R300 000 lump sum will be R171 000, minus R81 000 = R90 000,
Example 4: If a member has not elected a lump sum withdrawal benefit prior to retirement, and on retirement receives a lump sum benefit equal to R1 m, tax on that will be R135 000 plus 36% on R100 000 =. R171 000. If we compare this with the total tax that the member in Example 3 paid (that is, R31 950 + R99 000 + R90 000 = R22O 950), it is clear that the member in Example 3 will have to pay an additional amount of R49 950 in tax because of his election to receive his lump sum withdrawal benefits in cash.
Members are therefore encouraged to rather preserve their lump sum benefits in a preservation fund, a retirement annuity fund or another retirement fund when they resign; as the benefit will then not attract tax and the full tax-free amount of R300 000 will be available on retirement.
For further information please feel free to contact us on 012 431 3300.