Civil servants who are taking early retirement or are resigning are still in the pound seats when it comes to the taxation on the payouts from their defined benefit retirement fund.
But they need to be careful about the choices they make if they take advantage of
changes to the rules of the Government Employees Pension Fund on gratuities paid out to
people resigning after the age of 55, says Anton Swanepoel of Alexander Forbes.
"A wrong choice could cost a civil servant plenty of money."
Members of any age who resign from the Government Employees Pension Fund can receive a
gratuity (what is known as a withdrawal benefit in a private sector fund) as a lump sum.
Since last year, when the rules of the were amended, members over the age of 55 can
access the full value they hold in the fund, with one condition, that it be transferred to
another retirement fund.
This normal gratuity for a member of the Government Employees Pension Fund is
calculated as follows: (The calculation is based on the member's average annual salary
calculated over the last 24 months. The average salary is multiplied by 7,5 percent
multiplied by years of pensionable service.)
Example:
Mr X, who is 57 years and six months old, resigns after 30 years service with a final
average salary of R100 000 a year over the last two years.
Final average salary:
R100 000
7,5 percent:
R7 500
Multiplied by 30 years service
R225 000
But because Mr X has more than 15 years of pensionable service his benefit will be
enhanced by 10 percentage points for each full year of pensionable service from a minimum
of five years to a maximum of 15 years. So Mr X will receive:
Gratuity
R225 000
Increased by 100 percent
R450 000
If membership of the fund has been less than five years service the amount of the
gratuity will not be increased.
A civil servant has an advantage over a member of a private sector pension fund in that
the gratuity (withdrawal benefit) can be withdrawn totally from the fund without any tax
liability.
If someone in the private sector takes a withdrawal benefit before retirement age and
does not transfer the amount into another pension, preservation or retirement annuity
fund, there would be a tax liability on any amount above R1 800.
Civil servants over the age of 55, having the option of taking their gratuity benefits,
have another significant advantage. They can get more than the normal gratuity benefit if
they decide to transfer their full retirement benefit (what is known as their actuarial
interest) in the fund to an approved retirement fund, such as a retirement annuity.
However, in making this decision you must calculate whether you would be better off
taking early retirement or taking the resignation benefits. Effectively you have three
choices:
* You can take early retirement within the Government Employees Pension Fund. There are
both pros and cons to this. You may maintain benefits that you would otherwise lose, such
as medical benefits. But there are disadvantages - your surviving spouse might receive as
little as 50 percent of your pension if you died, and historically increases in pensions
have not kept up with inflation. Finally you would be penalised by the number of years by
which you took early retirement;
* Take the gratuity benefit tax free; or
* Transfer the enhanced benefit (actuarial interest) to another approved retirement
fund. You must compare the pension you would be receiving, having taken early retirement,
against what you would receive by taking the enhanced transfer benefit. These calculations
must also include tax.
Swanepoel points out that this is not the end of the choices. He says the tax planning
opportunities must also be carefully considered or else you could find yourself out of
pocket.
He says there are three basic tax planning opportunities for people over the age of 55
taking the "resignation and transfer to another fund" benefit.
To get back to Mr X. If he took the the resignation transfer benefit he would be
entitled to a transfer value equivalent to R762 421 (This amount was calculated for
Personal Finance by the Public Servants Association).
FIRST TAX PLANNING OPPORTUNITY:
Mr X's total benefit of R762 421 should be transferred to a retirement annuity fund. Mr
X can then retire immediately from the retirement annuity fund after the transfer takes
place. He would be entitled to take a lump sum to a maximum of one third of the value of
the transfer benefit plus interest (if any). The remaining two thirds would have to be
used to purchase a pension (compulsory annuity).
For taxation purposes the enhanced benefit is divided into separate sections.
For example Mr X's R762 421 is made up of the following:
* The original gratuity benefit of R450 000. This amount is deemed, because it is an
entitlement in terms of the rules of the Government Employees Pension Fund, to be an own
contribution by the member to the retirement annuity fund and is therefore a tax
deductible amount; and
* The balance to make up the full actuarial difference.
(In the private sector, in simple terms, only the first R120 000 of a lump sum of a
retirement annuity is tax free.).
So when Mr X retires from the retirement annuity fund he will do his calculations for
tax purposes like this (Remember as Mr X is now a member of a private sector retirement
annuity fund he is also entitled to the R120 000 tax exemption against his lump sum).
Enhanced gratuity
(transferred amount)
R762 421
The one third lump sum
benefit is:
R254 140
Less tax exemption:
R120 000
Sub total
R134 140
But Mr X still has the R450 000 own contribution standing to his tax credit, which is
greater than the R134 140 on which anyone else would have to pay tax. He now has a tax
credit calculated like this:
Total amount which
qualifies for tax deduction
R450 000
Less one third "taxable"
lump sum
R134 140
Total credit for future use
R315 860
Swanepoel says through proper tax planning this entitles a retirement annuity fund
member to receive the full one third lump sum tax free.
SECOND TAX PLANNING OPPORTUNITY:
When Mr X buys an annuity (monthly pension) he is taxed on the income he receives at
his normal rate of tax.
He can reduce his taxable income by a maximum of 15 percent a year from the credit he
has standing to his name (First tax planning opportunity).
Example: Suppose the annuity (pension) Mr X was receiving from the remaining two thirds
(R508 280) was R50 000 a year, the tax on this amount (assuming no other income) before
the primary tax rebate would be R11 950.
Less Tax rebate
R3 515
Total tax payable
R8 435
But because Mr X has the tax credit (see first tax planning opportunity) he can reduce
the taxable income of R50 000 to R42 500 (R50 000 less 15 percent of taxable income
contributed to a retirement annuity fund).
If Mr X was in the private sector he would actually have had to make this contribution.
But because his R450 000 was deemed as an own contribution, it is treated as a deduction
without expenditure for that year)
So Mr X's income of R50 000 can then be reduced by 15 percent
Less 15 percent of R50 000
R7 500
Total taxable income
R42 500
Normal tax
R9 340
Less Rebate:
R3 515
Total tax payable
R5 825
This is a tax saving for Mr X of R2 610 in that year.
In terms of current legislation this calculation would apply every year until the full
R315 860 tax credit was used up.
THIRD TAX PLANNING OPPORTUNITY:
Say Mr X had been investing in a retirement annuity, over and above saving for his
retirement through the government retirement fund, and say the retirement annuity matured
when he reached 60.
He would have been able to use the tax credit he built up in the first tax planning
opportunity here again.
It works like this:
Maturity Value of
retirement annuity
R600 000
One third lump sum
R200 000
Tax calculated on normal
lump sum formula
R60 000
Tax credit from first tax
planning opportunity
R315 860
Remaining tax credit
R255 860
(A number of assumptions were made to make this calculation, including an average rate
of taxation of 30 percent. To avoid making the example too complex the calculation formula
has not been detailed).
Swanepoel says where private sector individuals would have to pay tax on any further
lump sums received from other retirement annuity funds, public servants would be entitled
to utilise their tax credit to enable them to receive further lump sums without tax
liability.
These calculations are meant only as a guide.
It is advisable for civil servants considering these options to get guidance from a
properly qualified financial adviser as the calculations are complex and no two cases are
the same.