The taxation of retirement fund lump sums, on resignation or on retirement, continues to cause confusion.
The first misconception seems to arise from the fact that when the retirement fund pays out the lump sum, it has to ask the South African Revenue Service (SARS) how much tax to deduct. The SARS looks at the recipient's tax situation on the last tax form submitted to establish the average rate of tax previously paid, and it tells the fund what tax to deduct from the lump sum which it expects to be taxable.
So when you receive your lump sum, an amount of tax has already been deducted. This is not, however, the end of the tax story. The amount the SARS has directed the retirement fund to deduct is merely an anticipated amount. When you fill in your tax form for the year in which the lump sum has accrued, you will need to reflect the lump sum. The SARS will then calculate the exact amount of tax that should be paid and will either ask you for more tax or refund an amount of tax to you.
So how does the SARS calculate the exact amount of tax?
If you have resigned from the fund, R1 800 will be tax free. Amounts paid into another fund may also be tax free, depending on what type of fund you are resigning from and what type of fund the lump sum is being paid into. For example, a transfer from a pension fund to a retirement annuity fund (RAF) is tax free.
The maximum amount that may be tax free is limited to the lump sum, and the minimum amount is limited to past contributions to the fund that have not been allowed as a tax deduction. Any balance is taxed at the higher of your average tax rate for the current year (excluding the lump sum) or the previous tax year.
If you retire from the fund, depending on the type of fund from which you are retiring, a formula or series of formulas will be applied. In terms of these formulas the maximum amount of the lump sum that can be tax free will be the greater of R120 000 or R4 500 multiplied by the number of completed years of membership of the fund. For a pension and retirement annuity fund there is no minimum that can be received tax free. For a provident fund the minimum tax-free amount is R24 000.
The formulas take account of the lump sum, years of membership of the fund (limited to 50 years), your average salary in the last five years (to a maximum of R60 000), previous contributions not allowed as a deduction and amounts previously received as a lump sum tax free. Any part of the lump sum that is not tax free will be taxed at the higher of your average rate for the current year (excluding the lump sum) and the previous tax year.
If you would like to check that SARS has applied the formulas correctly, you could ask your local SARS or your tax consultant for the formulas.
The Katz Commission has proposed changes to the way that lump sums from retirement funds are taxed. But until these are accepted by the government, lump sums from retirement funds will be taxed as described.