Every time the taxman moves to close a gap some one will come up with an answer.
There is some interesting retirement planning going on to reduce the tax bill at "retirement" using a variety of financial instruments.
Behind it all lies what is called the average rate of tax that is paid on retirement benefits when the lump sum is received.
When you retire your lump sum benefits are taxed at your highest average rate of tax either in your year of retirement or in the preceding year.
Normally you pay tax at progressive rates (called marginal rates). In other words the more you earn, the higher the rate you are taxed at on the amounts you earn over fixed levels. (See example at the end of the column).
So let us say that after deducting the tax-free portion, your lump sum from a retirement fund is R500 000.
What happens then is that a complex formula is used to work out your average income and tax rate to tax this lump sum.
The higher your average rate the more you pay in tax on the lump sum.
The obvious thing to do is to reduce your income as low as you can when you retire, particularly if you earn a lot.
In the year of retirement you should retire as early as possible in the tax year because then you are no longer being paid a salary and more importantly you lose all your non-pensionable income perks like car allowances.
In the year before retirement you should reduce your income to as low as possible by, for example, not earning additional commissions or doing paid overtime work.
There is another, but more risky way to reduce your average income.
Instead of retiring you resign. You transfer your pension fund money to either a preservation fund or a retirement annuity with no tax consequences.
The problem is to convince the taxman you have genuinely resigned and not merely disguised your retirement. If the taxman is of the opinion that you have disguised your retirement, then you are back to square one and probably a bit worse off because you would not have made use of the income reduction devices.
If you are retrenched or fired your case is stronger.
We would, however, not recommend you punch your managing director on the nose to get fired.
But you are still faced with the problem of not having any income on which to live for the next few years.
This is where past savings can come to your rescue.
As has been explained in past articles in Personal Finance there are a number of tax-free sources of income. By using these sources of income you reduce your average rate of tax to the minimum.
The two main products are investments in life assurance policies and unit trusts.
You can draw capital from your unit trusts without any tax consequences.
If you have a matured endowment policy that you have left invested with an assurance company, you can take the proceeds tax free.
If you have a policy that has not yet matured, you can borrow against it but remember to keep up the premiums. (If the policy is less than five years old you can only make a loan against the policy.) These loans are often available interest free.
There is yet another source but here you need to work the figures out with great care. This source is your friendly bank manager.
Some banks are agreeing to provide loans to individuals taking this route. So you live on your overdraft for two years; pay off the overdraft and interest with your lump sum and pay the taxman less.
But as I said work out the figures very carefully. You also cannot use your retirement funds as security for any loan facilities.
The final caveat: The taxman watcheth!