Retire: Tax on lump sums

When you retire, you can take a third of your retirement savings as a single payment or lump sum. The first R500,000 is tax-free. All previous withdrawals are added together and considered when determining the tax liability on the lump sum payment. This is called the principle of aggregation and it means that later benefits are taxed at a higher rate.

However, there are three key dates that might just give you a tax breather by excluding certain withdrawals.

Withdrawals

Tax liability only applies to withdrawals made after certain dates. There are three key concepts here:

Severance benefits:

For the purposes of this blog, severance benefits are the odd one out. It’s not part of the retirement lump-sum tax-free benefit as it is an amount payable by an employer to an employee. However, it’s still important to take note of severance benefits within the context of retirement planning.

The key date: Any severance benefit withdrawals prior to 1 March 2011 are excluded from the tax-free lump sum allocation of R500,000.

Withdrawal benefit:

What is it? A withdrawal benefit kicks in when you leave your retirement fund prior to your retirement age for reasons other than retirement, death, or retrenchment.

The key date: Withdrawals before 1 March 2009 won’t be considered as part of your tax-free lump sum benefit. So if you withdrew from your previous company’s pension fund before 1 March 2009, those withdrawals won’t be taken into account, enabling you to withdraw a greater tax-free amount.

Retirement benefits:

What is it? This benefit is paid out upon death, if you are retrenched, or upon retirement.

The key date: Benefits paid prior to 1 October 2007 won’t form part of your tax-free lump sum allocation.

Hold on (just a little bit longer)

If you have discretionary savings available, it’s a good idea to keep your retirement savings invested to maximise compounding, and rely on your savings to cover your monthly expenses. Another option is to use your tax-free portion to cover your monthly expenses (as opposed to a single payment) before you dip into the reserves that are liable for tax. By doing this, you allow your pension savings to grow some more.

Remember, the money in your retirement fund grows tax-free while it’s invested, but you will get taxed once you start to withdraw from it.

Saving for retirement is the biggest investment most of us will ever make. Sadly, it can also be very complicated. In this monthly blog, we try to answer some of the retirement questions we hear most often, ranging from which products are best suited to different circumstances to efficient tax treatments. Words by Carina Jooste.