Tax Benefits on Retirement

INTRODUCTION

Contributions to pension, provident or retirement annuity funds are deductible for income tax purposes up to prescribed limits. Any remaining contributions not allowed as a tax deduction on retirement is applied as a tax exemption against income from annuities purchased on retirement, thus reducing or even eliminating a person’s tax liability.?

WHAT IS THE ALLOWABLE TAX DEDUCTION FOR CONTRIBUTIONS MADE TO RETIREMENT FUNDS?

A person may deduct total contributions made to a pension, provident and retirement annuity fund in a tax year against income to an amount equal to the lesser of:

1. R350?000, or
2. 27,5% of the higher of such person’s remuneration or taxable income, or
3. Such person’s taxable income before adding a possible taxable capital gain.

Where contributions exceed these limits in a tax year, the excess is carried over to subsequent tax years and may be applied as a tax deduction if future tax years, subject to the above limits.

WHAT HAPPENS IF A PERSON WHO MADE CONTRIBUTIONS THAT HAVE NOT YET BEEN ALLOWED AS A TAX DEDUCTION RETIRES?

Any contributions made to a pension, provident and retirement annuity fund that had not yet been allowed as a tax deduction and assessed as such by the South African Revenue Service will:

1. First be applied as a tax deduction against any lump sum that the person may opt to take; and
2. The balance will be applied as a tax exemption against annuity income purchased with the remainder of the interest in a pension, provident or retirement annuity fund.?

Please take note of the following:

1. Before the exemption against annuity income is allowed, the value of the disallowed contributions must first be assessed by the South African Revenue Service at the end of the tax year in which the excess contributions are made. This means that it will only be applied as an exemption from the tax year following the tax year in which the excess contribution was made.
2. Once it is assessed, the exemption against annuity income is not applied on a pay-as-you-earn basis, and it may only be claimed on assessment at the end of the tax year. The exemption is also only applied against annuity income purchased with proceeds from retirement funds, and not against other income.?

Example

Joe retires from a retirement annuity fund. At the time of his retirement, he had made assessed contributions in the amount of R5 000?000 to retirement funds that had not been allowed as a tax deduction. Joe opts to receive a lump sum of R500?000 and uses the balance to purchase an annuity. In the first year after retirement, the annuity income is R1 000?000.???

Effect:

1. R500?000 of his assessed contributions to retirement funds not previously allowed as a tax deduction will be used as a deduction against the lump sum of R500 000, and the lump sum will therefore not be taxable. There will be R4 500?000 left of the R5 000?000 that had not been allowed as a tax deduction.?
2. R1 000?000 of the remaining contributions of R4 500?000 that had not been allowed as a tax deduction will be used as an exemption against the R1 000?000 annuity income, which means that none of it will be taxable.??
3. The remaining R3 500?000 will be carried over to the next tax year to be tax-exempted against Joe’s annuity income.

WHAT HAPPENS IF A PERSON WHO MADE CONTRIBUTIONS THAT HAVE NOT YET BEEN ALLOWED AS A TAX DEDUCTION OR EXEMPTION DIES?

Where a person who has not yet retired from a retirement fund dies, the trustees of such funds may give the dependants/beneficiaries of the deceased member the option of taking the benefit:

1. as a lump sum, or?
2. as an annuity (income), or?
3. as a combination of a lump sum and an annuity.?

Beneficiaries of a deceased person who had retired and was receiving income from an annuity purchased with funds from a retirement fund may be afforded the same options, depending on the type of annuity purchased.

Any contributions to retirement funds that had not been allowed as a tax deduction or exemption, will be tax-deductible against lump sums paid to the dependants or beneficiaries, as the lump sum payable on death to beneficiaries or dependants are deemed to have accrued to the deceased fund member. Any remaining contributions that had not been allowed as a tax deduction or exemption will however not be exempted against annuity income accruing to dependants or beneficiaries, as this exemption is only available to the person who made the contributions (the deceased).?

Retirement fund benefits are normally not subject to estate duty. However:

1. If a lump sum smaller than the value of the contributions to retirement funds that had not been allowed as a tax deduction or exemption is paid to the beneficiaries or dependants, the value of such lump sum will be included in the estate of the deceased as deemed property for estate duty purposes; or
2. If a lump sum equal to or bigger than the value of the contributions to retirement funds that had not been allowed as a tax deduction or exemption is paid to the beneficiaries or dependants, the value of such contributions not allowed as a tax deduction or exemption will be included in the estate of the deceased as deemed property for estate duty purposes; or
3. If no lump sum is paid to the beneficiaries or dependants, no amount will be included in the estate as deemed property for estate duty purposes and therefore no estate duty will be payable in respect thereof.

Example

At the time of John’s death, he had made contributions in the amount of R6 000?000 to retirement funds that had not been allowed as a tax deduction or exemption. Therefore:???

1. If a lump sum smaller than R6?000 000 is paid to John’s beneficiaries or dependants, the implications are as follows:

Estate Duty Implications

The value of the lump sum paid to John’s beneficiaries or dependants will be included in John’s estate as deemed property for estate duty purposes.

Tax Implications of the Lump Sum Received by the Dependants or Beneficiaries

The value of the contributions not allowed as a tax deduction or exemptions against compulsory annuity income, will serve as a tax deduction against the lump sums received. As the value of such contributions (R6?000?000) will be bigger than the lump sum paid, no amount will be taxable and therefore no tax will be payable.?

Tax Implications of the Annuity Received by the Dependants or Beneficiaries

The annuity will be taxable in the hands of the beneficiaries or dependants as normal income. No exemption will be allowed against such annuities.

1. If a lump sum equal to or bigger than R6?000?000 is paid to John’s beneficiaries or dependants, the implications are as follows:

Estate Duty Implications

R6?000?000 will be included in John’s estate as deemed property for estate duty purposes.

Tax Implications of the Lump Sum Received by the Dependants or Beneficiaries

The value of the contributions not allowed as a tax deduction or exemption against compulsory annuity income, i.e. R6 000 000 will serve as a tax deduction against the lump sums received. The excess of the value of the total lump sum that exceeds R6?000?000 will be taxed in John’s hands in terms of the following tax table:

Please note that the application of the above tax table is cumulative over a fund member’s (in this instance John’s) lifetime and the following lump sums received previously will influence such person’s tax liability:

1. Lump sums received from a pension, provident, retirement annuity or preservation fund on retirement on or after 1 October 2007; and
2. Lump sums received from a pension, provident, retirement annuity or preservation fund on withdrawal (before retirement) on or after 1 March 2009; and
3. Severance benefits received from an employer upon ceasing employment on retrenchment, or disability or at the age of 55 or older on or after 1 March 2011.?

Tax Implications of the Annuity Received by the Dependants or Beneficiaries

If a portion of John’s retirement interest is paid as an annuity to his beneficiaries or dependants, such annuity will be taxable in the hands of the beneficiaries or dependants as normal income. No exemption will be allowed against such annuities.

1. If no lump sum is paid to John’s beneficiaries or dependants, the implications are as follows:

Estate Duty Implications

No amount will be included in John’s estate as deemed property for estate duty purposes.

Tax Implications of the Annuity Received by the Dependants or Beneficiaries

The annuity will be taxable in the hands of the beneficiaries or dependants as normal income. No exemption will be allowed against such annuities.

IN CLOSING

Contributing more than the allowable tax deduction to a retirement fund could result in tax and estate duty benefits, if applied correctly. Speak to your financial planner for more information on this topic.?

Disclaimer:

This communication is for information purposes only and does not constitute financial advice in any way or form. It is important to consult a financial planner to receive financial advice before acting on any information contained herein. PWM and its directors, officers and employees shall not be responsible and disclaim all liability for any loss, damage (whether direct, indirect, special or consequential) and/or expense of any nature whatsoever, which may be suffered as a result of, or which may be attributable, directly or indirectly, to the use of, or reliance upon any information contained in this communication.