Navigating your financial decisions at retrenchment

Retrenchment is one of life’s unforeseeable events that can destabilise a person both emotionally and financially. It’s a life event that should automatically trigger a re-assessment of your financial plan. That said, there are critical decisions that need to be made during the retrenchment process and at the point of retrenchment which we unpack in greater detail below.

Your retirement fund benefits

If leaving your employment as a result of retrenchment, you will need to make important decisions regarding the funds invested in your employer’s pension or provident fund. In this context, the retirement funds held in pension and provident funds are referred to as ‘retrenchment benefits’ because they apply only to occupational funds where a member has experienced loss of employment. This means that if your loss of employment results from your employer ceasing operations or your position becoming redundant as a result of general operational requirements, your retirement funds will be regarded as retrenchment benefits for tax purposes.

With regard to these retrenchment benefits, you have the following options available:

(i) Withdrawing some or all of your capital

While preserving your accumulated capital is generally the best option, tough economic times may prevent you from doing so – and it may be necessary to access some or part of your capital to tide you through a period of unemployment. However, before deciding to withdraw your capital, it is advisable to first understand the tax implications of doing so. As a taxpayer, you are eligible for the once-off opportunity to withdraw R550 000 from your retirement funds without paying tax, keeping in mind that your retrenchment benefit, together with your severance benefit, is considered and taxed as a combined retirement lump sum benefit. This means that, upon retrenchment, the first R550 000 of your combined severance and retrenchment benefit will be tax-free. Any additional funds withdrawn will be taxed at the retirement tax tables. Keep in mind, however, that SARS will take all previous taxable withdrawals, retirement (including retrenchment benefits), and severance benefits into account – including severance benefits that accrued on or after 1 March 2011, and retirement lump sum benefits that accrued on or after 1 October 2007. If you are unsure whether you’ve made any previous withdrawals, it is best to ask your service provider for a tax simulation so that you have full insight into how you will be taxed when making a withdrawal.

(ii) Preserving your capital

If you are in the fortunate position to preserve your capital, you have the following options available:

  • Leave in employer’s retirement fund: If the retirement fund rules permit, you have the option of leaving your funds in the employer’s retirement fund where it will continue to enjoy investment growth until you reach formal retirement age.
  • Transfer to a preservation fund: Another option is to transfer your funds into a preservation fund which is an investment vehicle specifically designed to house pension or provident fund capital. Fund transfers to a preservation fund are tax neutral and there are no costs involved in the process. A notable benefit of a preservation fund is that you are permitted one full or partial withdrawal before normal retirement age, which could be useful where your financial future remains uncertain.
  • Transfer to a retirement annuity: Another way to preserve your retirement capital is to transfer your funds into a retirement annuity. If you already have a retirement annuity in place that is aligned with your investment goals, you may choose to transfer the funds into your existing RA. Again, this transfer will have no tax implications and will not involve any additional costs or fees.
  • Transfer to new employer’s fund: If you have secured alternative employment, you can transfer your retirement funds to your new employer’s pension fund. However, keep in mind that there are tax implications if transferring from a pension fund to a provident fund, so be sure to get advice.

Your severance package

The cash payment that your employer pays you as a result of your loss of employment is referred to as your ‘severance benefit’. While legally you are entitled to one week’s remuneration for each year of completed service, the specifics should be set out in your employment contract so be sure to get advice in this regard. Over and above your severance benefit, you will be entitled to any monies owed in respect of overtime, leave, commission, incentives, and/or bonuses. As mentioned above, the tax treatment of a severance benefit is the same as when withdrawing from your retirement fund, keeping in mind that you will be taxed on a combination of both benefits. SARS will therefore consider the combined value of your severance and retrenchment benefits, with the first R550 000 being tax-free with any additional withdrawal amounts being taxed as follows in the 2024 tax year:

Taxable income (R)             Rate of tax

1 – 550 000                           0% of taxable income

550 001 – 770 000               18% of taxable income above 550 000

770 001 – 1 155 000           39 600 + 27% of taxable income above 770 000

1 155 001 and above          143 550 + 36% of taxable income above 1 155 000

Once again, you have several options regarding your severance benefits and it’s advisable to view these funds strategically. If you foresee needing the money in the short term, it may be appropriate to house the cash in an interest-bearing account until you have more certainty regarding your future. Alternatively, you can consider investing this capital into a discretionary unit trust portfolio where it can achieve investment growth over the longer term. If you have debt, you could use a portion of the funds to settle some debt so as to reduce monthly expenditure and provide some relief. That said, keep in mind that a balance should be found between paying off your debt and ensuring cash flow while you seek alternative sources of income.

Your group risk cover

Another factor to consider is that upon retrenchment your group risk cover will fall away, and it is advisable to take steps to ensure you remain protected. Many group policies provide a continuation option that allows those leaving employment to retain their life and disability cover in their personal capacities. Generally, group life insurers allow 60 days from the date of retrenchment or resignation in which to exercise the continuation option, so be sure to investigate this option as soon as possible. When exercising this option, keep in mind that you will not need to be medically underwritten and your cover will remain free from premium loadings, making this option generally more cost-effective than seeking cover in your personal capacity. In addition, there is very little administration involved in processing a continuation option with the added benefit that no break in your insurance cover occurs. As a side note, this may be an opportune time to completely review the levels of life, disability, and severe illness cover that you require in order to ensure that you are adequately protected given your changed financial circumstances.

Your medical aid

When going through a retrenchment, it is important to ensure that you remain on a medical aid and that your membership is not interrupted – bearing in mind that a break in membership of more than three months can give rise to waiting periods, exclusions, and potentially late joiner penalties. If your company runs an in-house medical scheme, you will need to move off that scheme and onto an open medical scheme in your personal capacity. If you are on an open scheme through your employer, you can remain on that scheme but will be personally responsible for the payment of your premiums. If cash flow is an issue, you may want to consider downgrading your plan option.

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