“We need R200,000 urgently. Can you cash in our preservation fund?”

Remember in our previous article, how we received this request from a client followed shortly by a query: “Why were we only paid R130,000?”

What a question to get first thing on a Monday morning, but put yourself in their position – you expect one thing, you’re told what to expect, and then you get something less than expected.

Feverishly, I dig out the file, pull up the calculations, and recheck my figures. Come with me as I run through the calculation once again.

So, the first question I asked was…

Has the client reached retirement age?

This one was easy since I knew her age. Retirement can take place at any point after reaching the age of 55. Since she was retiring from a preservation fund, there wasn’t an employer issue such as when a client is allowed to retire. Often times, an employer will have a fixed retirement age in place somewhere between 60 and 65.

Has the client previously retired?

Not asking this question would be like building a home without first laying a foundation. If I got this wrong, she’d be making a serious donation to SARS.
I asked the client the question. Her reply: “No, I’ve never retired from any pension fund, provident fund, or retirement annuity.”

Great, two out of two done and dusted! Next question…

How much would the client need to cash in?

This isn’t usually a problem. That’s because the first R500,000 of your pension, provident, or retirement annuity is allowed tax-free. In the unusual case where you’ve contributed more towards a retirement fund than allowed to deduct in a specific tax year, you could increase this tax-free amount at retirement even further. But that’s an article for another day.

In my client’s case, she had never retired, and she had a Provident Preservation Fund worth just north of R200,000, which was the exact amount she needed. She agreed that this met with her expectations, and I went ahead with processing the retirement. She would get her R200,000 paid out tax-free within the next ten working days – case closed, or so we thought.

But things didn’t turn out like we had expected

She was only paid R130 000. The rest went to SARS.

The first thing I did, called the client back, and ask: “Are you sure you have never retired in the past?”

“No, I haven’t.”

“Were you retrenched from your previous job?”

“No, I resigned.”

“What did you do with your retirement fund from that company?”

 “I cashed it in”

And that’s how I discovered the problem.

So how does the tax calculation work if this is your first time retiring?

Take Peter, for example, he has a Provident fund worth R800,000 and he wants everything paid to him in cash. He has never retired from any fund in the past and he has never taken a retrenchment package.

Step one: Work out the taxable income based on all lump sums received by Peter

What we do is add all the following together:

• Current Provident fund value – R800 000 plus
• All previous retirement fund lump sum withdrawal benefits received since 1 March 2009 – R0, plus
• All previous retirement fund lump sum benefits received since 1 October 2007 – R0, plus
• All previous severance benefits received since 1 March 2011 – R0
• Combined this gives us an amount of R800 000

Then we deduct from this any contributions to any retirement fund which were not previously allowed in terms of tax laws. In Peter’s case, there weren’t any.

Step two: Calculate the tax payable on this amount

Here is the calculation:

Peter retires, takes all of his provident funds in cash, and pays R63,000 in taxes. He walks away with R737,000 in his pocket.

And since Peter has never taken any retirement fund lump sum in the past, nor been retrenched, the balance of the calculation (Steps 3 to 5) is not done.

And how does the retirement tax calculation work if this is your second time around?

This time we’ll take Freddy as an example, he has the same size Provident fund worth R800,000 and he also wants everything in cash.
He has never retired from any fund in the past, but he has withdrawn from one in 2014 when he took R50,000. Last year he took a retrenchment package of R600,000.

Step one: Work out the taxable income based on all lump sums received

What we do is add all the following together:

• Current Provident fund value – R800,000, plus
• All previous retirement fund lump sum withdrawal benefits received since 1 March 2009 – R50,000 plus
• All previous retirement fund lump sum benefits received since 1 October 2007 – R0, plus
• All previous severance benefits received since 1 March 2011 – R600,000
• Combined this gives us an amount of R1,450,000

Then we deduct from this any contributions to any retirement fund which were not previously allowed in terms of tax laws. In Freddie’s case, there weren’t any.

Step two: Calculate the tax payable on this amount

Here is the calculation:

The result of the first tax calculation is that an amount of R274,500 in tax is owed.

Step three: Work out the taxable income based on all previous lump sums received

Now we add everything together except for the current retirement fund he is retiring from:

• All previous retirement fund lump sum withdrawal benefits received since 1 March 2009 – R50,000 plus
• All previous retirement fund lump sum benefits received since 1 October 2007 – R0, plus
• All previous severance benefits received since 1 March 2011 – R600,000
• Combined this gives us an amount of R650,000

Then we deduct from this any contributions to any retirement fund which were not previously allowed in terms of tax laws.  As mentioned above, there weren’t any.

Step four: Calculate the tax payable on this amount

The result of this tax calculation shows that an amount of R27,000 in taxes was paid.

Step five: Deduct the tax in step four from the tax in step two

The difference between the two is the amount of tax that Freddie now owes SARS:

• Tax on all lump sums (Step 2) – R274,500
• Less: Tax on previous lump sums (Step four) – R27,000
• Tax on current lump-sum retirement benefit – R247,500

Conclusion

Two major points to consider before taking a cash portion when retiring:

• Don’t retire from your pension, provident, or retirement annuity fund without first checking in with SARS. Ask them, “Am I allowed the full R500,000 cash portion tax-free?”
• And secondly, remember to keep your own records in a file. How else will you dispute SARS’ conclusions?

In my client’s case, hers wasn’t a planned retirement.  She needed a certain amount in cash ‘as in right now’ regardless of the tax payable.

But the lesson for you is: Don’t ever risk your retirement nest egg on a faulty tax assumption.

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