Taxation Laws Amendment Bills, 2007(Retirement Lump Sum Payouts)

Informal Hearings

13 March 2007

Retirement Funding Basics

3

Three Basic Types of Retirement Funds

• Pension Funds (Employment Plans)– Example: Private sector– Example: GEPF

• Provident Funds (Employment Plans)– Example: Unions

• Retirement Annuity Funds (Individual)– Example: Contractual savings

4

Three Retirement Stages

• Stage #1: Contributions

• Stage #2: Fund Growth

• Stage #3: Withdrawals– Lump sum payouts– Conversion to annuities

• Guaranteed annuities• Living Annuities

5

Contributions: No Change

• Pension Funds– Employee contributions are deductible up to 7,5 of

employee salary– Employer contributions are deductible up to 20% of

employee salary• Provident Funds

– No deductions for employee contributions– Employer contributions are deductible up to 20% of

employee salary• Individual Retirement Annuity Funds

– Member contributions are deductible up to 15% of contributions (after set offs for employment contributions)

6

Growth: Tax Removed

• Under current law, all retirement funds (i.e. pension, provident and retirement annuity funds) are subject to the Tax on Retirement Funds– 9% rate (down from a 25% historic high)– The tax impacts only retirement fund interest,

rental and foreign dividends

• The Tax on Retirement Funds removed– As of 1 March 2007– 1 final payment still due

7

Withdrawals

• Permissible withdrawals– Only a certain percentage of fund value can be

withdrawn upon retirement (i.e. as a lump sum)– All the excess must be converted to a (guaranteed or

living) annuity with funds withdrawn steadily over the post-retirement period

• Taxation of permissible withdrawals– Lump sum withdrawals: tax exemption plus tax

averaging– Annuity withdrawals: growth is tax-free before

withdrawal, but fully taxable upon withdrawal

Lump Sum Proposals

9

Permissible Lump Sums

• Current Law– Pension and individual retirement annuity funds can

be withdrawn equal to: the greater of 1/3rd of total value or an amount bearing a per annum annuity up to R1 800)

– Provident Funds can be fully withdrawn

• Proposal– The monetary R1 800 threshold will be abandoned– The new monetary threshold will be R50 000 as this

sums relates to the 2/3rds (the change prevents fees from outpacing potential benefits)

10

Tax-Free Lump Sums: “Say Good Bye to (2) Old Formulas”

• Formula A (Good Bye!)– Y = 15/1 x N/50 x 1/3rd x Average Salary– N means years of service– Maximum years (50) and salary (R60 000)

• Formula B (Good Bye!)– Z = C + E (minus) D– C means formula A, E means nondeductible

contributions and D means pre-1941 deductible contributions

• Formula C stays (exemption for pre-1998 government years of service)

11

Tax-Free Lump Sums: New Regime

• Under the new regime, the tax-free lump sum equals:– R300 000 (+)– Previous non-deductible contributions (+)– Pre-1998 Government employment

(formula C)

• The new regime ends all reliance on “salary” and “years of service”

12

Taxable Lump Sums:“Say Good Bye to Complex Averaging”

• Formula 5(10) (Good Bye!)– Y (A divided by [B + D – (C + L)]; (x)– (B – L); (+)– (L x R)– Along with other inputs

• In essence, the taxable lump sum was determined with reference to non-lump sum taxable income over 2 years with an 18% minimum

• Avoidance Scheme: Wealthy taxpayers reduced their lump sums to an 18% rate by relying on tax-free preference dividends

13

Taxable Lump Sums: New Regime

• Under the new regime, the taxable lump sum is:– Taxed at 18% for the first R300 000 taxable

amount (+)– Taxed at 36% for the remainder

• Complex averaging and planning opportunities removed

14

New Lump Sum Regime: Combined

• Once the tax-free lump sum is considered, the net effect is a separate rate schedule for lump sums, as follows:– Previous non-deductible contributions and

pre-1998 Government employment

(formula C) are tax-free– Next R0 to R300 000 is tax-free– Next R300 001 to R600 000 is taxed at 18%– Next R600 001 & more is taxed at 36%

15

New Lump Sum Benefits: Rationale

• Simplicity (including a simplified withholding regime)

• The new regime skews tax benefits in favour of lower- and middle-income earners

• High net worth individuals no longer benefit from the use of preference share schemes

• Note: The lump sum formulas are applied on a cumulative basis over the taxpayer’s lifetime

16

Effective Date

• 1 October 2007

• The delayed effective date provides sufficient time for operational systems changes

• Stay tuned for more changes!!