If you leave your pension or provident fund, you may want to transfer your retirement savings to a preservation fund or a retirement annuity (RA) to protect your savings until you retire. However, before doing so, you should be aware of the main features of both vehicles and the long-term consequences of using either one.
Preservation funds
A preservation fund is designed to "warehouse" your retirement savings until you retire. The main features of a preservation fund are:
- A preservation fund is a life assurance product.
- No tax is payable on the transfer (translocation) of your retirement savings to a preservation fund. Tax is deferred until retirement.
- You pay investment costs when you transfer your retirement savings to a preservation fund. The costs can be as high as six or seven percent of your initial investment, and up to 2.5 percent a year thereafter.
In most employer-sponsored retirement funds, annual costs are likely to be lower, particularly with the bigger funds, because the trustees negotiate lower asset management fees.
- There are two types of preservation funds - pension and provident preservation funds. If you are transferring from a defined benefit or a defined contribution pension fund, you must transfer to a pension preservation fund. If you are a member of a provident fund, you must transfer to a provident preservation fund.
The reason for this is that pension and provident funds are taxed differently at retirement.
- Your retirement age from the preservation fund is the same as that applied by the sponsored pension fund from which you transferred your retirement savings. The rules of the fund from which you have withdrawn the money pertain.
So, if in terms of the pension fund's rules, your retirement age is 65, you will only be able to withdraw your pension benefits from the preservation fund when you turn 65.
However, if, after transferring your savings to a preservation fund, you join another retirement fund and you then retire from that fund, you will have to retire from the preservation fund at the same time.
- If you want to transfer your retirement savings to a preservation fund, your past employer must be a "participating employer" in the preservation fund. This is an administrative requirement of the Income Tax Act, and is met by your employer signing a declaration.
- You cannot remain a member of a preservation fund past the age of 69.
- You cannot make additional contributions to a preservation fund. If you joined a preservation fund as a result of a previous transfer, you cannot add to the fund. You must join a new preservation fund.
- The length of your membership of the initial retirement fund is the main factor that determines the tax-exempt portion of any lump sum that you commute at retirement.
- You are permitted to make one withdrawal from a preservation fund before retirement. This concession is useful if you are in a financial crisis. The withdrawal may be a portion or the entire amount of your savings in the fund. The one withdrawal may only take place after you have transferred your retirement capital to the preservation fund. Any deduction by your employer from the amount you transfer to a preservation fund - for example, to repay a loan or to cover losses or theft or to fulfil a maintenance order - counts as the one withdrawal from the fund.
- If you have already made one withdrawal from your preservation fund, you can appeal to the trustees of the preservation fund to make a further withdrawal in cases of special and exceptional financial hardship, such as unemployment.
The trustees are obliged to obtain permission from the South African Revenue Service before granting you the further withdrawal.
- You may transfer money from a preservation fund to the sponsored pension fund of a new employer without paying tax.
However, if your retirement savings are in a preservation pension fund and you transfer them to a provident retirement fund, the amount transferred is subject to tax.
- When you withdraw your savings from a retirement fund, you are permitted to place a portion of the money in a preservation fund and a portion in an RA. The separation of the transfer benefits is not taxed. The portion transferred to the RA is not regarded as the single withdrawal you are permitted from a preservation fund.
You may not transfer funds from a preservation fund to an RA.
- The first R1 800 you withdraw from a preservation fund is tax-free. This tax concession applies only once. You are taxed at your average rate on any withdrawal after the first R1 800.
- Your retirement savings in a preservation fund are protected against claims from creditors in the event of sequestration.
- All preservation funds are managed as "new generation products", provided by either a life assurance company or a linked investment product company.
A new generation product means you have a wide array of choices about the underlying investments and may mix and match your investments on an ongoing basis. Most of the underlying investments are unit trust funds or portfolios selected by experts that are modelled on your investment risk profile.
Retirement annuities
The main features of an RA, that is used to preserve your retirement savings transferred from a retirement fund, are as follows:
- You can transfer your retirement savings to an RA from either a provident fund or a pension fund. You need to be wary if you transfer your savings from a provident fund, because you will lose the accumulated tax benefits on any contributions made to the provident fund with after-tax money. In other words, you will not be able to claim back the contributions on which you have already paid tax.
- You do not pay tax on the amount you transfer from your retirement fund to an RA. Taxation remains deferred until retirement.
- The years you belonged to your retirement fund are cancelled when calculating the tax-free amount of the portion (up to a maximum of one-third) you want to commute to a lump sum on retirement. Instead, the tax-free amount is determined by the years you belonged to the RA only, and this can have a significant effect on your commutation, particularly if you are close to retirement.
The tax-free portion is calculated by multiplying your years of membership of the RA by R4 500.
- You may transfer your retirement savings to an existing RA. This can help overcome the negative affect of losing the years you belonged to the retirement fund, particularly if you have had the RA for many years.
- Unlike a preservation fund, you can add money to an RA.
- Your retirement savings incur investment costs when you transfer them to an RA. These costs can be as high as six or seven percent of your retirement savings.
Next week:
Timing your retirement