Resigning from your job?
We all have that friend, and many of us ARE that friend.
A friend of one of the WellSpent editors recently appeared, cap in hand, and Provident Fund resignation forms in the other, eager to hear some sage words as to what the tax effects would be should he withdraw his accumulated balance from a provident fund he had previously contributed to.
Said friend was moving on, and were it not for his prior and proactive HR department, Friend might not have even known that he had any accumulated investment lying around.
So what if he takes the money and not the box?
As Friend is not retiring, rather he is resigning, were he to cash-out from his Provident Fund, the tax rules on Provident Fund withdrawals would apply.
The tax rules are fairly straight forward on a withdrawal. Below is the maths I jotted down for Friend on a scrap piece of paper.
Current value of Provident Fund: R300, 000
Then apply the “withdrawal” benefit tax table.
|Taxable income from lump sum benefits||Rate of Tax|
|0 – R25, 000||Nil|
|R25, 001 – R660, 000||R0 + 18% of taxable income exceeding R25, 000|
|R660, 001 – R990, 000||R114, 300 + 27% of taxable income exceeding R660, 000|
|Exceeding R990, 000||R203, 400 + 36% of taxable income exceeding R990, 000|
NOTE: These rates are from the 2019 tax year (1 March 2018 – 28 February 2019) . Click here to access the SARS Tax on Retirement Lump Sums Page.
In Friend’s case, he wanted to exit his Provident Fund in full, so he was not transferring any balance to a provident preservation fund. These are funds where you can house your provident fund money until you decide what to do with it at some later stage. Various Life Assurance companies offer this facility.
Were he to have made any transfer to such a preservation fund, the balance that would have been subject to tax would have reduced by the value of such transfer.
The maths was easy; Friend would get R25, 000 tax free, and pay 18% on the balance. 18% on R275, 000 equates to R49, 500. Friend would therefore clear R250, 500.
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Purely co-incidentally, this editor had a similar query from another friend one day later, who was also considering a withdrawal from his provident preservation fund. Let us for illustration purposes say that his accumulated value was R1 million. The tax he would pay on a full withdrawal would be as follows:
36% of R10, 000, being the difference between R990, 000 and his R1 million accumulated value.
Add to that, R203, 400.
Friend #2 would therefore suffer tax of R3, 600 + R203, 400 = R207, 000 and walk away with R793, 000.
These tables are designed that you can jump straight to the row that applies to your accumulated value (amount exceeding R990, 000) and calculate the tax payable at that row. You could have alternatively worked out the tax for each band and summed it all together.
These tables do change from time to time, so it’s important to make sure you’re using the correct tables.
Comparing taxable apples to taxable apples
You’ll notice that the effective rates of tax are quite low for smaller withdrawal amounts. Friend #1 paid an effective rate of tax of 16.5%, while Friend #2 paid tax at 20.7%.
Suffering effective tax rates this low could be quite compelling if you consider that you might have otherwise bought an annuity with this money and been subject to marginal income tax rates on this money later in life. Then again, chances are your income would be lower, and you might likely only suffer income tax at these sorts of effective rates in any event.
Another way to look at exiting at these lower tax levels, is that it could be a great way to access after-tax money that can be invested for the long-term, giving rise to capital gains, which are taxed at much lower rates than an annuity.
Things change though, when you consider withdrawal amounts in the millions. Let’s take an example of a R5 million withdrawal amount. This would require paying an effective rate of tax of 33%. Again, this allows you to prevent being subject to paying marginal rates on an annuity when you reach retirement on this money, but does mean crystalizing a material tax burden now. The benefits of tax deferred investing for the long-term should then definitely be considered.
What’s the money for?
These two examples above simply illustrate the tax implications of withdrawing from a provident fund or provident preservation fund. It doesn’t deal with whether you should or shouldn’t be withdrawing in the first place.
People changing jobs and deciding to ‘cash out’ their preservation fund money is regarded as one of the biggest culprits for the lack of financially secure retirements in this country. The prospect of accessing a nice sum of money now, to deal with things like settling credit card balances, undertaking home renovations, or investing in ‘brand new You’ by spending less than you earn, are all compelling reasons as to why you might want to take away a little from your future self, for the betterment of your current financial position.
We won’t get into this discussion now, as this article is really just about the tax effects on a withdrawal benefit, but it would be irresponsible for us to not at least draw to your attention to the fact that it is very challenging to catch-up on these withdrawals at a later stage in life.
If you’re going to withdraw cash from your provident fund when you leave your job, it stings less if the balance of that account isn’t too large. The bigger the balance gets, the more tax you’ll pay, giving a provident fund or provident preservation fund a momentum. If you think there’s a better investment opportunity for the money (and it had better be pretty good), then seek sound financial advice and put the money to work.
We’ve written quite a few other great pieces on how tax affects your various investments and retirement outcomes – here they are: