Retrenchment: Retirement annuity or preservation fund?

If you’ve recently been retrenched or lost your job as a result of the Covid-19 pandemic and extended lockdown, it is likely that you have important decisions to make regarding your retirement fund benefits if you were contributing towards your employer’s pension or provident fund. Although first choice is always to preserve your capital, tough economic times and unprecedented unemployment rates means that you may have no choice but to access some or all of your money. Let’s have a closer look at the options available to you on retrenchment.

Accessing your retirement fund

In the same way as a resignation allows you to withdraw your retirement fund in cash, retrenchment will allow you to access your pension or provident fund savings subject to tax. However, unlike a resignation, any withdrawal taken from your fund upon retrenchment is taxed as per the retirement tax table. Should you choose to take all or a portion of your fund in cash, this withdrawal is added to any severance payment you receive and taxed as per the retirement tax table below:

Taxable Income Rate of Tax
R1 – R500 000 0% of taxable income
R500 000 – R700 000 18% of taxable income above R500 000
R700 000 – R1 050 000 R36 000 + 27% of taxable income above R700 000
R1 050 000 and above R130 500 + 36% of taxable income above R1 050 000

Keep in mind that any and all previous withdrawals and/or severance benefits are also taken into account when calculating the total taxable withdrawal meaning that it is a cumulative total and not calculated on a pre-withdrawal basis. As such, be aware of any previous withdrawals in order to avoid incurring any unintended or unplanned tax deductions. Remember these withdrawals will also be accounted for in the future once you decide you retire from your retirement funds.

Investing in a preservation fund

A preservation fund is essentially a tax-efficient investment vehicle designed to house your retirement fund benefits when you leave the employ of a company or business. You have the option either an in-fund preservation, where you remain a non-contributing member of your current fund or you may transfer to a private preservation fund.

If you have been contributing towards a pension fund, you will need to transfer to a pension preservation fund, and this transfer will be tax-free. On the other hand, if you have been contributing towards a provident fund, you will need to transfer to a provident preservation fund, once again on a tax-free basis. Both of these funds are governed by the Pension Funds Act. If you choose to preserve your retirement benefits you make take a portion in cash and transfer the balance to the preservation fund or simply transfer the full amount to the preservation fund.

One of the distinct advantages of a preservation fund is that it allows investors to make one full or partial withdrawal before retirement, which is generally set at age 55, with any withdrawal being subject to the withdrawal tax tables. In times of uncertainty such as we find ourselves in presently, this is a particularly attractive benefit. If you are uncertain about your financial future, unsure about your employment prospects, or believe there is a strong likelihood you will need to access your capital before age 55, then a preservation fund allows excellent flexibility. However, tax plays a very important role in the decision-making process as any lump sum withdrawal you make from your preservation fund will impact you at a later stage should you wish to make a withdrawal from a different preservation fund.

There is no limit on the number of preservation funds you can have, although when withdrawing from an active pension or provident fund you are not permitted to split your retirement benefit across multiple preservation funds. While you are permitted to make a once-off full or partial withdrawal from each preservation fund in your name, bear in mind that the tax-free amount of R500 000 is calculated on the cumulative amount withdrawn and not per preservation fund.

A key feature rule of a preservation fund is that you are not permitted to make further contributions towards it. However, the accumulated credit remains invested and may be allocated to, and switched between, the available underlying funds on the platform subject to Regulation 28 restrictions. Preservation funds are also transferable between platforms and service providers. If, at a later stage, you choose to transfer your preservation fund to a retirement annuity, you are able to do so with the knowledge that you can then start making additional contributions towards your investment. However, note that you cannot transfer a retirement annuity to a preservation fund.

No tax is paid on the investment returns generated within a preservation fund, and the proceeds of such a fund do not form part of your deceased estate. This has the effect of reducing your estate duty and protecting your assets from potential creditors. It is important to nominate beneficiaries to your preservation as a guide to the fund trustees when determining the allocation of funds amongst your financial dependents in the event of your death.

Legislation permits you to retire from a preservation fund anywhere from the age 55, although there are currently different rules regarding pension preservation and provident preservation funds. If you retire from a pension preservation fund, you have the option of taking up to a maximum one-third lumpsum withdrawal, which will be subject to tax. Thereafter, you are obliged to use the remaining two-thirds to purchase an annuity to provide you with an income during retirement.

On the other hand, when retiring from a provident preservation fund, you currently still have the flexibility to withdrawal anything up to 100% in cash with any remaining balancing being used to purchase an annuity to provide income. Currently, if you emigrate from South Africa and break your tax and SARB residency, you are permitted to make a full withdrawal from your preservation fund even if you have made a previous withdrawal. Note that the recent tax amendment bill announcement an intention to change this rule to include a three year waiting period from the time you break tax residency with South Africa before you may withdraw your preservation and/or retirement annuity funds, although this has not yet been ratified and passed into law.

Investing in a retirement annuity

While a retirement annuity is an attractive and tax-efficient investment option because it allows you the freedom to contribute additional amounts on a monthly, quarterly, annual or ad hoc basis, it is important to bear in mind that once you have invested your money in an RA, you cannot access the funds before age 55. Therefore, it is important to take into account your current age, future employment prospects, and your short-to-medium term financial needs before committing your retirement benefits to a retirement annuity. Early retirement from a retirement annuity is only possible where ill-health prevents you from working and generating an income, or in the case of permanent emigration. A foreign national whose work permit has ended and intends on returning to their home country may also withdraw from a retirement annuity.

As in the case of preservation funds, there is no tax payable when transferring your retirement benefit to a retirement annuity. If you are undecided whether to set up a retirement annuity or preservation fund, bear in mind that legislation permits you to transfer your preservation fund tax-free to a retirement annuity at a later stage, but not vice versa. Therefore, should you choose to transfer your preservation fund benefit to a retirement annuity you forfeit the one-time access option before retirement.

Like preservation fund investors, retirement annuity investors are not taxed on investment returns within the investment, and the proceeds fall outside of the investor’s estate meaning that no estate duty is payable on these funds. Once again, it is essential to nominate the beneficiaries to your retirement annuity as guidance to the fund trustees when determining your financial dependents.

You may retire from your retirement annuity anywhere from the age 55, at which point you have the option to take a one-third cash withdrawal and purchase an annuity with the remaining two-thirds, or to purchase an annuity with the full amount. The latter option could result in cashflow problems later in retirement as all your funds will be housed in compulsory investments, and it is therefore always better to seek independent advice in this regard.

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