More than one withdrawal by a member of a preservation fund - even if it is in line with the rules of the fund - can have serious tax consequences for the fund and its members.
If you have retirement money invested in a preservation fund, find out from your fund's trustees whether you are at risk of paying tax on all monies you invest in the fund.
Personal Finance recently reported on a case heard by John Murphy, the Pension Fund Adjudicator, who ordered the Wealth Builder Pension Preservation Fund to pay up after the fund had refused to do so at the request of one of its members.
The member, who was employed by Southern Life until his retrenchment, was entitled to an early withdrawal benefit from his company's retirement fund.
He consulted his employer and his financial adviser and chose to take a cash benefit of R82 000 and to transfer the balance of about R250 000 into a preservation fund.
Based on advice given to him, he believed he would be entitled to a further withdrawal from the preservation fund in the future.
When he later wanted to make a withdrawal, the fund refused, based on a general directive from the South African Revenue Service (SARS), which states that no more than one withdrawal benefit may be paid by a preservation fund prior to a member reaching the age of 55.
The directive further says that any amount deducted from the sum that is being transferred from a retirement fund to a preservation fund should be regarded as the member's first and final withdrawal benefit from the preservation fund.
However, Murphy ordered the fund to allow him to make the withdrawal because the rules of the preservation fund allowed members to make one withdrawal before retirement.
Furthermore, he said, the fund's rules did not include a provision deeming a withdrawal made before transferring the benefit to the preservation fund as constituting the single withdrawal under the SARS rules.
Therefore, although the member had not transferred his entire withdrawal benefit to his preservation fund, the rules of the fund permitted him to make a single withdrawal from his investment account.
Murphy says funds, employees and SARS sometimes fail to recognise that the rules of a preservation fund determine the benefits to which members are entitled. In other words, if the rules differ from the SARS notice, the rules prevail, Murphy says.
"We have made this point more than once and did so again in the case of the Wealth Builder Pension Preservation Fund," Murphy says.
Commenting on the issue in general, Vlok Symington, the manager of employment income at SARS, says that, while SARS agrees with Murphy's decision, if a retirement fund's rules allow for a second withdrawal, it may have a serious impact on the fund's tax status.
The Income Tax Act grants a retirement fund preferential tax status if (and only if) its rules:
- have been registered by the Financial Services Board; and
- comply with the requirements prescribed by SARS.
The requirements for a preservation fund to qualify for preferential tax status are that its rules must prohibit the payment of a so-called second withdrawal from the fund.
No withdrawal from a preservation fund is allowed if the benefit transferred to the fund was reduced for any reason prior to the transfer.
Preservation funds were given until January 30, 1999 to comply with the SARS requirements. Any preservation fund that did not make use of this opportunity to regularise its affairs lost its SARS-approved status.
The effect of this is that the preservation fund will be subject to normal tax; transfers by members to the fund will attract tax; and benefits will, in general, be fully subject to tax at marginal rates in the members' hands.
It is, therefore, clear that loss of approved status not only negatively affects the preservation fund but also its individual members.
Symington suggests that if individual members are concerned about the tax status of their preservation fund, they should speak to their trustees.
What is a preservation fund?
- A preservation fund is an investment vehicle available to you, as a member of an existing pension or provident fund, should you resign or be retrenched. You are also entitled to buy a preservation fund if your retirement fund is liquidated (closed down). It is only available to preserve funds until you need it at retirement. You cannot transfer to a preservation fund when you retire from employment. Both a preservation fund and a retirement annuity can be used to "preserve" your retirement money until you retire. By transferring to a preservation fund, you defer taxation on the transfer benefit until you retire.
Be Warned
- As a general rule you cannot transfer your retirement fund money into a preservation fund if you take any cash from the amount that is transferred from your retirement fund into the preservation fund. You have to transfer the full amount into a preservation fund.
Alternatively you can split your retirement fund money between a retirement annuity and a preservation fund. In this case, you will still be able to make one withdrawal from the preservation fund before the age of 55.
You may want to access some money from your preservation fund for emergecies. Generally all retirement vehicles lock in your investment until the age of 55.