At retirement, you will need to decide whether to take part of your retirement fund as a cash lump sum or use the full value to purchase an annuity income. While access to tax-efficient capital can be useful, this decision should be made in the context of your broader retirement income plan.

Since the implementation of the two-pot retirement system on 1 September 2024, members also need to understand how their vested, savings and retirement components are treated at retirement. In broad terms, your vested component remains subject to the pre-two-pot rules, which may allow you to commute up to one-third, depending on the fund and any vested rights. Any remaining balance in your savings component can be taken as cash or used to purchase an annuity, while your retirement component must generally be used to secure a retirement income, unless the de minimis rule applies.

For the 2026/2027 tax year, the retirement fund lump sum benefits tax table remains unchanged, with the first R550 000 of taxable retirement lump sum benefits taxed at 0%. Importantly, this is a lifetime allowance and not a per-fund benefit. As such, any decision to take a lump sum should be carefully weighed against your capital needs, tax position, income requirements and estate planning objectives.

Previous lump sum withdrawals

One of the most common misunderstandings when it comes to the tax-free lump sum is that it applies separately to each retirement fund. In reality, the retirement lump sum tax table is applied cumulatively across previous retirement fund lump sums, withdrawal benefits and severance benefits. This means that if you have previously withdrawn from a retirement fund, received a severance benefit, or taken a retirement lump sum from another fund, these amounts will be taken into account when SARS calculates the tax payable on your current lump sum.

Care should also be taken not to view the lump sum tax table in isolation. While withdrawing a lump sum at an effective tax rate of 18%, 27%, or 36% may appear attractive when compared to a marginal income tax rate of 45%, bear in mind that tax on annuity income is generally deferred until the income is actually drawn. In many cases, preserving capital within a retirement income structure can result in a more tax-efficient outcome over the longer term.

Capital needs in retirement

Before deciding whether to take a lump sum, it is important to carefully assess your capital requirements, both at the point of retirement and over the years that follow. Once your retirement savings have been used to purchase a living annuity or guaranteed life annuity, you will not generally be able to access ad hoc lump sums from that structure, except where the balance in your living annuity is below R150 000, in which case you may withdraw the full amount. A living annuity allows you to select an income drawdown rate within the prescribed limits, but it does not allow you to make irregular capital withdrawals as and when the need arises. For this reason, you should consider whether you are likely to need access to capital for once-off or irregular expenses such as home renovations, vehicle replacement, overseas travel, medical appliances, relocation costs, family commitments or frail care planning.

The composition of your investment portfolio

Your broader investment portfolio should play an important role in determining whether a lump sum withdrawal is appropriate. If the majority of your wealth is housed within compulsory retirement funding structures, taking a portion in cash at retirement and investing it in a discretionary portfolio may provide valuable flexibility. Discretionary capital can assist with emergency funding, tax-efficient drawdowns, estate liquidity and irregular capital needs later in life.

On the other hand, if you already have sufficient discretionary investments, cash reserves or tax-free savings, it may make more sense to use a greater portion of your retirement fund to secure your retirement income. Either way, the decision should not be based solely on the amount available to commute, but rather on the balance between compulsory and discretionary assets, the sustainability of your retirement income, your tax profile and your need for future flexibility.

The nature of your annuity income

The type of annuity you intend to use will also influence your lump sum decision. A guaranteed life annuity provides a predetermined income for life, transferring longevity and investment risk to the insurer. Depending on the escalation option selected, this income may increase annually, although the initial income will generally be lower where higher escalation or inflation-linked options are chosen. The benefit of a guaranteed life annuity is certainty, but this certainty comes with limited flexibility.

A living annuity, by contrast, provides more flexibility as you are able to select an annual drawdown rate between 2.5% and 17.5% of the investment value. However, this flexibility brings with it both investment risk and longevity risk. If your drawdown rate is too high, or if investment returns disappoint, your capital may reduce over time, leaving you with less income in later retirement. In both cases, having some discretionary capital available can be useful. For life annuity investors, discretionary funds can help supplement income where inflation erodes purchasing power. For living annuity investors, discretionary capital can reduce pressure on the annuity during periods of poor market performance or allow for more tax-efficient income planning.

Estate planning and liquidity

Your lump sum decision should also be considered in the context of your estate plan. Keep in mind that retirement funds and annuities are treated differently from an estate planning perspective, and the liquidity needs of your deceased estate should be assessed before retirement decisions are finalised.

A guaranteed life annuity may cease on death, unless a spouse’s pension, guarantee period or capital protection option has been selected, while a living annuity, on the other hand, allows you to nominate beneficiaries who may elect to continue with an annuity, take a lump sum, or choose a combination of both, subject to tax. Discretionary investments held in your own name will generally form part of your estate and may be used to provide liquidity, although they may also attract estate duty, executor’s fees and capital gains tax consequences.

If your estate is likely to face liquidity constraints, taking a lump sum and investing it appropriately may help ensure that there is sufficient capital available to meet estate costs, taxes, accrual claims, maintenance obligations or bequests. However, this needs to be balanced against the potential loss of retirement income and the tax consequences of withdrawing the capital.

Other retirement funds

Another factor to consider is whether you will have future opportunities to access retirement capital. If you are retiring from your only retirement fund, this may be your final opportunity to access a meaningful lump sum, and your decision should be made with this in mind. However, if you have other retirement funds from which you intend to retire at a later stage, you may have further opportunities to commute capital in future. Once again, keep in mind that the tax table will still be applied cumulatively.

Investment risk

It’s important to keep in mind that where a lump sum is withdrawn and invested in a discretionary portfolio, those funds will be exposed to investment risk. While this can create opportunities for growth, it also means that poor market timing, inappropriate asset allocation or excessive withdrawals can materially affect the sustainability of your retirement plan. Conversely, using your retirement capital to purchase a guaranteed life annuity transfers much of the investment and longevity risk to the insurer, ensuring an income for life regardless of market performance. This can provide significant peace of mind, particularly for retirees who do not have other sources of secure income. The trade-off, however, is reduced flexibility and, depending on the product selected, potentially limited capital available for beneficiaries.

Tax planning

If you choose to take a lump sum and invest it in a discretionary portfolio, it is important to understand the tax implications of drawing from that investment. Depending on the underlying assets and investment structure, you may be liable for tax on interest, dividends and capital gains. These taxes should be assessed together with all your other sources of income, including annuity income, rental income, interest income and any ongoing employment or consulting income. Care should also be taken not to draw too little from your compulsory investments purely to reduce tax in the short term. While this may preserve your taxable income initially, it could result in the premature depletion of discretionary capital, leaving you overly dependent on taxable annuity income later in retirement. Effective retirement planning requires a balance between tax efficiency, income sustainability, liquidity and flexibility.

Ultimately, the decision to take a lump sum at retirement should be strategic rather than automatic. While the ability to access tax-efficient capital can be extremely useful, it must be weighed against your need for sustainable income, your tax position, your estate planning objectives and the composition of your broader investment portfolio. As with most retirement decisions, the best outcome is seldom achieved by looking at one factor in isolation. Rather, it requires an integrated plan that takes account of your immediate needs, your long-term income security and the legacy you wish to leave behind.

Have a super day.

Sue