Use tax rules on retirement to your advantage
Wouter Fourie CEO of Ascor® Independent Wealth Managers and a former winner of the FPI Financial Planner of the Year award
Calculating and paying taxes is burdensome at any stage of life, but even more so when you are on the cusp of retirement. At this important junction in your life, a bad tax decision could cost you money, both in unnecessary expenses and by lowering the amount of money left in your pension fund to grow and look after you for the next decade or three.
When you get ready to retire, you should keep in mind that different tax rules apply to different types of investments and withdrawals. For instance, you can withdraw a third of your pension, pension preservation or retirement annuity fund when you retire, and 100% of your provident or provident preservation fund.
The amount you withdraw will be subject to taxation, but you will benefit by paying no tax on the first R500,000, and the remaining amount will be taxed according to favourable tax rates.
Since March 1 2011 certain severance benefits (lump sums) have been taxed according to these favourable rates.
While the rules vary and require the help of a seasoned tax practitioner, a rule of thumb is that retirement has its tax advantages, particularly when you reach the age of 65. You do not pay tax if you earn less than R122,300, and when you reach age 70 the tax-exempt amount is even bigger at R136,750. In addition, you can earn R34,500 in interest tax-free.
There are five main reasons to withdraw some of your retirement savings when you prepare for retirement. They are:
To repay debt
It may make more sense to pay off any outstanding debt, such as the last money owed on your home, and start your retirement debt-free. The saving in debt costs may be more than the taxes.
To start a business
Many people see retirement as the start of a new chapter and plan on starting a new business. This could place your savings at risk.
To plan your estate
If your fund does not allow you to purchase a pension plan outside the fund or does not pay out money to your spouse when you die, it may be prudent to extract the maximum amount and invest it in something that would give you these benefits.
To have an emergency fund
We suggest an amount equal to between three and six months of your monthly income to provide for small unexpected expenses, like house and/or car repairs and even provide for co-payments for medical costs.
Major health incidents will usually be covered by your medical aid and gap cover, which is why it is a good idea to have both.
To fund goals in retirement
You may want to buy a new car or take a vacation.
In The Ultimate Guide to Retirement in South Africa, our chapter on tax at retirement contains many different scenarios. There are, however, some rules you should keep in mind:
Not all payouts are equal
The tax deductions vary between severance payouts, pension withdrawals, long-service awards, accumulated leave and many other forms of end-of-career payments. It will be in your interest to understand which of these forms of payments attract no tax, or the least tax, and structure your payouts accordingly.
Do not rush your decision
Face it, you saved all your working life to reach this point and hopefully retire financially secure. Do not put your pension funds at risk by making a hasty decision that could negatively affect your cash flow at retirement and the funds available for further investment.
There are tax benefits to being retired
Remember that you will not be taxed in the same way when you are retired as when you were still working. You should keep this in mind, as a payment or withdrawal deferred until after you retire may be taxed at a lower rate than when you were still employed.
Run the numbers
A certified financial planner will be able to calculate different scenarios and help you decide. Could you be making more money by keeping your money invested, or would you be in a better position to pay off your credit card debt? These decisions will vary from person to person, based on your goals, life stage and the size of your pension savings.
Read more on Ascor® Retirement planning