Jun 29, 2020
4 minutes
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:
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:
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.
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:
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.
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.
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.
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.