TAX TALK Tax On Retirement Payments (Part 2)

In this series of articles, Cameron Kotze the Tax Partner at Ernst and Young discusses some topical tax issues for our readers.

MANY of us contribute to a pension fund during our work life. This contribution is usually calculated as a percentage (in many cases 7,5 per cent) of our pensionable salary.The employer also contributes an amount to the fund on behalf of the employee.A pension fund can make various payouts.Firstly, it can pay out an amount when the employee resigns to take up employment with another employer.If the employee does not transfer the full pension fund benefit to another approved retirement fund, the amount not transferred to an approved fund is taxed at the employee’s average rate of tax on other taxable income for the tax year.The tax rate may not be lower than 17,5 per cent.Secondly, a pension fund can make a pay out on retirement of the employee.Normally the pension fund pays out one-third of the employees’ pension fund benefit as a single pay out and the balance is paid out as a monthly pension.The Income Tax Act specifically exempts the single payout on retirement from income tax.The monthly pension however is taxed because the Income Tax Act specifically includes such amounts in the employees’ taxable income.Thirdly, a pension fund can make a pay out on death of the employee.Normally the pension fund pays out the whole benefit in such a case.Part of this payout (not more than 49,9 per cent) ends up in the hands of the deceased employee’s estate or family and another part (at least 50,1 per cent) is used to buy a monthly pay out for the deceased employee’s dependants.The Income Tax Act specifically exempts the payout on death from income tax.The monthly pay out to the deceased employees’ dependants is taxed because the Income Tax Act specifically provides that such amounts be taxed.Fourthly, a pension fund make pay out the benefit of each member if the fund is dissolved or terminated because the employer has become insolvent or closes down.The amount received by each employee is specifically taxable and the average rate of tax (but a minimum of 17,5 per cent) is applied to the taxable amount.Finally, an employee may withdraw some of the pension benefit that has been built up over time from the pension fund in terms of the rules of the fund.The amount received by the employee is also taxed at the average rate of tax applicable to other income of the taxpayer in the year the amount is withdrawn from the pension fund subject to a minimum tax rate of 17,5 per cent.Whenever an amount is taxable at the average rate of tax, the Receiver of Revenue must be approached for confirmation of the rate of tax to be used.In recent times Revenue officials have directed that the maximum rate (35 per cent) of tax must be applied to the amount that is taxable.The taxpayer is entitled to submit information to substantiate a lower rate of tax based the actual income for the tax year.Next time we look at provident fund payouts.Should readers have queries, they are invited to send them to cameron.kotze@za.ey.com.This contribution is usually calculated as a percentage (in many cases 7,5 per cent) of our pensionable salary.The employer also contributes an amount to the fund on behalf of the employee.A pension fund can make various payouts.Firstly, it can pay out an amount when the employee resigns to take up employment with another employer.If the employee does not transfer the full pension fund benefit to another approved retirement fund, the amount not transferred to an approved fund is taxed at the employee’s average rate of tax on other taxable income for the tax year.The tax rate may not be lower than 17,5 per cent.Secondly, a pension fund can make a pay out on retirement of the employee.Normally the pension fund pays out one-third of the employees’ pension fund benefit as a single pay out and the balance is paid out as a monthly pension.The Income Tax Act specifically exempts the single payout on retirement from income tax.The monthly pension however is taxed because the Income Tax Act specifically includes such amounts in the employees’ taxable income.Thirdly, a pension fund can make a pay out on death of the employee.Normally the pension fund pays out the whole benefit in such a case.Part of this payout (not more than 49,9 per cent) ends up in the hands of the deceased employee’s estate or family and another part (at least 50,1 per cent) is used to buy a monthly pay out for the deceased employee’s dependants.The Income Tax Act specifically exempts the payout on death from income tax.The monthly pay out to the deceased employees’ dependants is taxed because the Income Tax Act specifically provides that such amounts be taxed.Fourthly, a pension fund make pay out the benefit of each member if the fund is dissolved or terminated because the employer has become insolvent or closes down.The amount received by each employee is specifically taxable and the average rate of tax (but a minimum of 17,5 per cent) is applied to the taxable amount.Finally, an employee may withdraw some of the pension benefit that has been built up over time from the pension fund in terms of the rules of the fund.The amount received by the employee is also taxed at the average rate of tax applicable to other income of the taxpayer in the year the amount is withdrawn from the pension fund subject to a minimum tax rate of 17,5 per cent.Whenever an amount is taxable at the average rate of tax, the Receiver of Revenue must be approached for confirmation of the rate of tax to be used.In recent times Revenue officials have directed that the maximum rate (35 per cent) of tax must be applied to the amount that is taxable.The taxpayer is entitled to submit information to substantiate a lower rate of tax based the actual income for the tax year.Next time we look at provident fund payouts.Should readers have queries, they are invited to send them to cameron.kotze@za.ey.com.