How much tax must you pay on lump sums when you retire?

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7 January 2022

When you retire from a retirement fund - be it a pension, provident, preservation or retirement annuity fund - you may take some of the money out in cash subject to rules that apply to the various components in these funds.

When you take the allowable cash portion from a retirement fund at retirement, it is currently taxed as follows:

Many people only withdraw the tax-free amount from their retirement fund(s) at retirement. They then invest the rest in an annuity (a pension) to provide them with an income in retirement. This means that no tax is paid on lump sums. They only pay income tax on their pension income provided by their chosen annuity.

Say you have taken cash from a retirement fund earlier (before you retire), this is what happens:

The scale shown above shows lifetime limits. So, if you matured a retirement annuity a few years before retiring, and took R250 000 out tax-free, the tax-free amount available to you now is only R300 000.

If you take early retirement as part of a retrenchment, a slightly different set of rules apply. Retrenchment packages normally include a number of parts, which are:

The severance pay is taxed in the same way as a retirement lump sum. This means that if your severance pay is greater than R550 000, there will be no tax-free amount available if you take a cash lump sum when you retire from your retirement fund. The rest of the package will be taxed as income.

For example: If you are given a severance package of say R600 000, and you take another R550 000 from your retirement fund, your lump sum tax will be as follows:

Severance package
R600 000
Tax free amount
R550 000
Taxable amount taxed at 18%
R50 000
R 9000
After tax Severance amount
R600 000 – R 9 000 = R591 000
Retirement lump sum
R550 000
Tax free
R0
Taxable amount
R550 000
Taxed at 18%
R169 999
R30 600
Subtotal
R380 001
Taxed at 27%
R380 001
R102 600
Total tax
R133 200
After tax retirement lump sum
R550 000 – R133 200 = R416 800

To show the difference between retirement tax and tax on retirement benefits taken (withdrawn) before reaching retirement age, take a look at the current table. Minimum retirement age in terms of the Pension Funds Act is 55. Minimum retirement age in terms of the Pension Funds Act is 55.

There is another aspect of taxation of lump sums at retirement. Tax deductible contributions made by individuals to retirement funds during their working lives are limited to 27.5 percent of the greater of their remuneration or their taxable income. There is an overall limit of R350 000 per annum In terms of S11(k) of the Income Tax Act.

Tax deductible contributions reduce your taxable income, providing a considerable benefit. For example (using the 2024/2025 SARS Tax Table and you were under 65 years old): If you earned R200 000 of income and were taxed on it, you would pay R18 765 in tax for that year. If you contributed 27.5% to a retirement fund, you would contribute R55 000 and would only be taxed on R145 000 - which means you have to pay R8 865 in tax for that year. Your pension contribution in this case would save you R9 900 in tax, which would reduce the net cost of your retirement fund contribution to R55 000 - R9 900 = R45 100. Therefore, it is worthwhile having tax deductible contributions.

If you contribute more than the allowed amount, that extra contribution accumulates until you contribute less or until you retire. At retirement, any retirement fund contribution that was ‘not allowed’ may either increase your tax-free amount, or it may be offset against tax on your pension.

People often forget about retirement annuity contributions that were not allowed. However, SARS keeps track of them. So, it’s well worth enquiring if you have any ‘disallowed contributions’ on record.

If, for example, you find an accumulated amount of R35 000 of these contributions that were not allowed, your tax-free lump sum can either increase from R550 000 to R585 000, or you can deduct the R35 000 from your taxable income from your chosen annuity (pension) in your first year of retirement. This appears in S10C(2) of the Income Tax Act.

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