Important tax considerations: resignation or retirement from public sector funds

Members of public sector retirement funds face some difficult decisions when considering their options with respect to resignation or retirement. In light of this, we have compiled a guide to highlight the different tax implications of public sector benefits which may apply on resignation and retirement.

Jun 29, 2020

4 minutes

Members of public sector retirement funds face some difficult decisions when considering their options with respect to resignation or retirement. In light of this, we have compiled a guide to highlight the different tax implications of public sector benefits which may apply on resignation and retirement.

Public sector funds are specified in paragraph (a) and (b) of the definition of “pension fund” in the Income Tax Act. The Government Employees Pension Fund (GEPF) is one example of such a public sector fund, specifically a paragraph (b) fund, but there are many others.

Lump sum benefits paid by public sector funds were only taxed with effect from 1 March 1998, and benefits which relate to pre-1 March 1998 years of service, retained their tax-free nature (referred to as pre-1 March 1998 vested rights). The tax-free portion of the benefit is determined by using the formula prescribed in paragraph 2A of the Second Schedule to the Income Tax Act (previously referred to as “Formula C”), being:

A = B / C x D

Where:

A

represents the taxable amount to be calculated

B

represents the total number of completed years of membership from 1 March 1998 until the date of exit from the public sector pension fund

C

represents the total number of completed years of membership of the public sector pension fund until the date of exit from the public sector pension fund

D

represents the lump sum benefit payable upon exit from the public sector pension fund

It is important to realise that the value of D in the formula may differ depending on the scenario, as set out below:

  • On retirement from a public sector fund, the formula only applies to that portion of the benefit an individual takes as a lump sum, and not the total benefit or the portion of the benefit used to purchase an annuity.
  • On resignation or retrenchment from a public sector fund, the formula is applied to the full fund benefit, irrespective of whether that benefit is taken as a lump sum or transferred to another approved fund.
  • A transfer to a preservation fund or retirement annuity (“RA”) followed by withdrawal or retirement from the receiving fund, will result in the formula being applied to the full amount transferred out of the public sector fund to the receiving fund.

Once the taxable portion of the benefit has been determined using the formula, the relevant tax table (withdrawal or retirement/retrenchment – refer to Annexure A) must be applied to calculate the tax payable in respect of the specific benefit.

The table overleaf illustrates the difference in the pre-March ‘98 tax-free value, looking at two scenarios. In Scenario 1, the employee’s benefits are transferred to a preservation fund from which that member later retires, while in Scenario 2, the member retires directly from a public sector fund.

Comparison of taxes payable

 
Scenario 1
Scenario 2
  The employee’s public sector fund benefit is R9m, which is transferred to a preservation fund on resignation. Subsequently, the member retires from the preservation fund, taking one third as a lump sum. The balance is used to purchase an annuity. The member retires directly from the public sector fund with a total benefit of R9m. One third of the benefit is taken as a lump sum and the balance is used to purchase an annuity.
Lump sum benefit payable on exit from public sector fund (“D”) R9 000 000 1/3 of R9 000 000 = R3 000 000
Completed years of service after 1 March 1998 (“B”) 22 years 22 years
Total completed years of service (“C”) 33 years 33 years
Par. 2A formula 22/33 x R9 000 000 22/33 x R3 000 000
Taxable portion of benefit calculated (“A”) = R6 000 000 = R2 000 000
Tax free portion of benefit (“D” – “A”) R9 000 000 – R6 000 000
= R3 000 000
R3 000 000 – R2 000 000
= R1 000 000
Tax on taxable portion of lump sum benefit applying relevant tax table* R3 000 000 – R3 000 000 = R0 (taxable portion of lump sum payable) R3 000 000 – R1 000 000= R2 000 000
R130 500 + 36% of (R2 000 000 – R1 050 000) = R472 500
After tax lump sum R3 000 000 R2 527 500

*Lump sum benefits are aggregated for the purpose of calculating the tax payable on a lump sum benefit. In other words, the following lump sums previously received by or accrued to the individual are taken into account when determining the tax that applies to the current lump sum benefit:

  • Retirement benefits received or accrued on or after 1 October 2007;
  • Withdrawal benefits received or accrued after 1 March 2009; and
  • Severance benefits received or accrued on or after 1 March 2011.

Please refer to Annexure A, for the applicable retirement tax tables, the withdrawal tax tables, and a summary of the steps to follow to calculate taxes payable in respect of a specific benefit.

Our example shows that the member may actually receive a smaller pre-March ‘98 tax-free benefit if retiring directly from the public sector fund. However, there may be other benefits which the member loses, for example, a medical aid subsidy, should transfer out of a public sector fund occur prior to reaching retirement age. This is an important factor to consider.

Can a member lose their pre-98 tax-free benefit when transferring to a preservation fund or retirement annuity?

In terms of the Second Schedule to the Income Tax Act, the pre-March ‘98 tax-free benefit will only be retained where benefits were transferred from a public sector fund to a pension fund, pension preservation fund, provident fund, provident preservation fund or retirement annuity fund (first transfer) after 1 March 2006.

With effect from 1 March 2018, the pre-98 tax-free benefit is also retained after a second transfer to a pension fund, pension preservation fund, provident fund, provident preservation fund or retirement annuity fund. However, the benefit is lost on a third transfer.

Consider all the options and implications

When advising your client, it is important to do a careful analysis of their circumstances. Consider their specific needs, the available options and possible tax implications before making any decisions.

Annexure A: Taxation of retirement fund lump sums

Retirement fund withdrawal benefit

Taxable income (R) Tax
0 – 25 000 0% of taxable income
25 001 – 660 000 18% of taxable income above R25 000
660 001 – 990 000 R114 300 + 27% of taxable income above R660 000
990 001+ R203 400 + 36% of taxable income above R990 000

To calculate the tax in respect of a withdrawal lump sum:

Step 1

Add current lump sum to all previous lump sums* and apply current withdrawal tax tables.

Step 2

Add all previous lump sums* and apply current withdrawal tax tables.

Step 3

Answer in step 1 minus answer in step 2 = tax payable on current withdrawal lump sum.

*Only retirement lump sums received or accrued on or after 1 October 2007, withdrawals received or accrued on or after 1 March 2009 and severance benefits received or accrued on or after 1 March 2011 must be taken into account.

Retirement lump sum or severance benefit

Taxable income (R) Tax
0 – 500 000 0% of taxable income
500 001 – 700 000 18% of taxable income above R500 000
700 001 – 1 050 000 R36 000 + 27% of taxable income above R700 000
1 050 001+ R130 500 + 36% of taxable income above R1 050 000

To calculate the tax in respect of a retirement lump sum:

Step 1

Add current lump sum to all previous lump sums* and apply current retirement tax tables.

Step 2

Add all previous lump sums* and apply current retirement tax tables.

Step 3

Answer in step 1 minus answer in step 2 = tax payable on current retirement lump sum.

*Only retirement lump sums received or accrued on or after 1 October 2007, withdrawals received or accrued on or after 1 March 2009 and severance benefits received or accrued on or after 1 March 2011 must be taken into account.

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Authored by

Janine Langenhoven

Legal Counsel

Salome Young

Legal Counsel

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