If your employer offers a work place retirement fund and you meet the qualifying criteria, you are legally obliged to become a member of the fund – it is a condition of your employment.
Few, if any employers allow their staff to chose between a pension and a provident fund (although different funds may exist for different levels of staff).
The objective of a pension fund (as well as a RA) is to provide its members with a monthly pension in retirement – you must use two-thirds of your investment balance to purchase an annuity.
The purpose of a provident fund is to provide its members with a cash lump sum in retirement (which can be used to purchase an annuity but it is not compulsory).
The three types of funds have different tax deductibility rules and limits; however, these, along with the other distinctions, are set to fall away within the next year or two. In terms of retirement reform proposed in the 2011 Budget, all three funds will become subject to the same tax deductibility and compulsory annuity rules.
Do I pay tax on a retirement fund?
The key attraction of a retirement fund is the tax concession – you do not pay tax on your retirement fund until you withdraw or retire from the fund. In addition, neither your contribution (up to the legal limits) nor the investment return earned by the fund is taxed.
You further benefit from low tax rates at retirement. The first R315 000 of any cash lump sum you receive is not taxed; the second R315 000 is taxed at 18% and the third at 27%. Any cash lump sum above R945 000 is taxed at 36%.
The monthly pension from your compulsory annuity will be taxed according to the prevailing personal income tax tables. As your retirement income is likely to be lower than your salary, your income will be taxed at a lower average rate than your deduction. The higher your marginal tax rate at the time you contribute to the fund (the highest marginal tax rate of 40% presently kicks in at taxable income of R580 000), the more you stand to benefit from this tax rate differential.
These tax concessions are important as they can add as much as 30% to the value of your pension.
If you withdraw from the fund (eg on changing jobs), any cash lump you take out will be taxed at a higher rate than on retirement. Only the first R22 500 is untaxed; the balance up to R600 000 is taxed at 18%, the next R300 000 at 27% and the remainder at 36%. All in all you pay R81 300 more tax on a cash lump sum of R945 000 or higher if you cash in your retirement fund early, so it pays to be patient. The earliest you can retire is at age 55.
Do I receive a lump sum when I retire, or a monthly pension?
At retirement you only qualify for the full lump sum if you are a member of a provident fund, you formally emigrate, or the total value of your RA fund falls below R75 000. If you are a member of a pension fund or retirement annuity you must use two-thirds of your proceeds to purchase an annuity (a monthly income stream).
At present, you can overcome these restrictions by withdrawing rather than retiring from your pension fund (you cannot withdraw from a retirement annuity fund). This will however have negative tax consequences, as cash lump sums are taxed at a higher rate on withdrawal than on retirement.
You should, in any event, think long and hard about converting your retirement investment into a cash lump sum. Remember, this money is intended to fund your living expenses for the rest of your life, not to pay down debt, go on a long holiday or start a new business. And even if you have no such plans, few people have the skill to invest their cash lump sum appropriately, to secure their standard of living for as long as they may live. You are likely to become victim of poor advice, high fees, and an inappropriate investment strategy, and you will likely outlive your capital.
However, much of this will become irrelevant in the not too distant future. To protect investors from themselves and their poor savings and investment habits (and thereby also the state purse), all fund members (including those in provident funds) will likely be forced to a) preserve their retirement fund on changing jobs) and b) take out a compulsory annuity with at least two-thirds of their fund balance on retirement.
In other words, you will not be able to convert your retirement fully into cash under any circumstances (although vested interests will be protected). You money must stay in a retirement fund (be it a work place fund, a RA or a preservation fund) until you retire, and then only one-third will be available as a cash lump sum.
When will I get my first payment?
This depends on how quickly your retirement fund administrator can “process” your retirement, in terms of dealing with the necessary paperwork and obtaining the necessary tax clearance certificates from SARS. Only once this is done can the money be transferred, either to your account or to the life insurance company from which you have bought your compulsory annuity. If your affairs are in order, you should receive your first annuity payment in the second month of your retirement. As the first month should still be covered by your final pay check, you should not be without a monthly income at any stage.
