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Pension Funds, Provident Funds and Retirement Annuities-Defining Them and Their Tax Implications

06 May 2010   (0 Comments)
Posted by: Author: Kieran Godden
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Pension Funds, Provident Funds and Retirement Annuities-Defining Them and Their Tax Implications
 
Pension, provident and retirement annuity funds are forms of retirement funding.Their main objective is to save money now in order to provide a secure and comfortable lifestyle later on in life.This article is a quick guide on how these three operate, and the implications of tax on the benefits they provide.

The main attributes of retirement funding options

Retirement Annuities

A retirement annuity fund is set up by an administrator, asset manager or insurer for the benefit of individual investors.The objective is to provide regular income to members upon their retirement or to provide lump sum benefits to dependants of such members upon the death of the members. Members of a retirement annuity fund cannot receive benefits before the age of 55. However, benefits can be transferred from one retirement annuity fund to another. Retirement annuities are often used as a retirement savings vehicle by self-employed people and those wishing to make additional provision for retirement.

The individual makes contributions to the retirement annuity by way of periodic or ad hoc payments before retirement. These contributions are tax deductible up to a limit as shown in the next section.The retirement annuity fund invests the contributions made until the individual’s retirement.The accumulated amount is then used to pay the individual regular pension amounts or a combination of regular pension and a cash lump sum. The individual can only take up to a maximum of one third of their pension benefits as a lump sum. It is compulsory to buy an annuity with the remaining benefit.
 
There are a number of different annuities available with various, flexible structures.These benefits are taxed differently as is shown in the following section.The regular pension amounts paid may or may not be increased to cushion the effects of rising prices on the purchasing power of the pension.If your employer contributes to a retirement annuity fund on your behalf, as of 1 March 2010, the amount paid will qualify as a tax deduction for you, subject to your allowable deduction. Currently, if your employer pays contributions to a retirement annuity fund on your behalf, you cannot claim a tax deduction.

If your employer contributes to an RA on your behalf, it will be able to take these contributions into account when calculating how much tax to deduct from your salary each month.This means you will not have to wait until your tax return is assessed to benefit from the deduction allowed for retirement annuity contributions.

Pension Funds

A pension fund is set up by an employer for the benefit of its employees.The objective is to provide pensions to the members (employees) upon their retirement. A pension fund may also provide other risk benefits such as death and disability benefits.

The employer makes contributions to the fund by way of periodic payments before retirement.The members may also contribute to the fund.Both contributions are defined in the rules of the fund and are tax deductible.The pension fund invests the contributions made until the individual’s retirement or withdrawal from the fund. The accumulated amount is then used to pay the individual a regular pension amount or a combination of regular pension and a cash lump sum. The regular pension amounts paid may or may not be increased to cushion the effects of rising prices on the purchasing power of the pension.

When the payment of benefits commences, up to one third of the value of the fund benefit may be taken in cash. The balance is taken as regular pension payments.
 
Provident Funds

A provident fund is set up by an employer for the benefit of its employees.The objective of this fund is to provide a cash lump sum benefit to its members (employees) upon their retirement.Members may choose how they wish to use their lump sum at retirement.The fund may also provide death and disability benefits.

The employer contributes to the fund and the members may choose to contribute.Contributions by the employer are tax deductible but member contributions are not.These contributions are invested by the fund and the accumulated amount is the member’s benefit on withdrawal or upon retirement.

The member is entitled to their full benefit as cash less the tax payable.The member may choose to purchase an annuity with part or all their benefit. 

Taxation of retirement contributions and benefits

Tax deductibility of contributions
(i) Pension fund contributions by members for current pension fund contributions, it is the greater of:
•7.5 per cent of remuneration from retirement funding employment, or
•R1 750.
Any excess may not be carried over to the next year.

For arrear pension fund contributions, the maximum tax deduction is R1 800 per annum.Any excess over R1 800 may be carried forward to the following year of assessment.

(ii) Provident fund contributions by members Provident fund contributions are not tax deductible.They are paid from post-tax income.Employer contributions to pension and provident funds are tax deductible, or paid from pre-tax income for the member.This deductibility is subject to a maximum of 20 per cent of salaries for the employer’s contribution to retirement funds and medical aid schemes.

(iii) Retirement annuity fund contributions by employees and employer For current retirement annuity fund contributions, it is the greater of:
• 15 per cent of taxable income other than from retirement funding employment, or
• R3 500 less current deductions to a pension fund, or
• R1 750.
Any excess may be carried over to the next year.

Taxation of benefits

In the taxation of any lump sum benefits, the taxable amount is the member’s lump sum benefit less any member’s own contributions not previously allowed as tax deductible.The taxation of such benefits can be summarised as follows: 
 
(i)Taxation of lump sum benefits on retirement; death; termination of employment due to redundancy; and termination of employer’s trade
 
Value of lump sumTax rates
Between R0 and R300 0000%
Between R300 001 and R600 000R0 plus 18% of taxable amount exceeding R300 000
Between R600 001 and R900 000R54 000 plus 27% of taxable amount exceeding R600 000
R900 001 and aboveR135 000 plus 36% of taxable amount exceeding R900 000
 
(ii) Taxation of lump sum benefits on withdrawal
 
Value of lump sumTax rates
Between R0 and R22 5000%
Between R22 501 and R600 000R0 plus 18% of taxable amount exceeding R22 500
Between R600 001 and R900 000R103 950 plus 27% of taxable amount exceeding R600 000
R900 001 and aboveR184 950 plus 36% of taxable amount exceeding R900 000

(iii) Taxation of monthly income during retirement

Any income earned during retirement is taxed using the scales published by the National Treasury annually.

Comparison of retirement annuity, pension and provident funds 

(i) Contributions
• A retirement annuity fund is a private arrangement fully owned by the member.Employers and employees can now contribute in a tax-efficient fashion to retirement annuity funds.

• Member and employer contributions under a pension fund arrangement are paid from pretax income.However, under a provident fund arrangement, member contributions are paid from post-tax income, whereas employer contributions are paid from pre-tax income.Retirement annuity fund contributions are paid from pre-tax income.The contributions paid from pre-tax income have upper limits given above.

• The retirement annuity benefits can be made paid up should an individual encounter financial difficulty that makes it difficult to keep up recurring premiums. There are restrictions in making such a move in pension and provident funds.

(ii) Benefits
• Pension and retirement annuity fund members can take up to a third of their retirement benefit as a lump sum. The remaining benefit must be used to provide a regular income.Provident fund members have the option to either take their entire retirement benefit as a lump sum or take only part of their benefit as a lump sum and use the remaining benefit to provide a regular income.The cash lump sums and regular incomes are taxed as shown above.

• Retirement annuity funds do not allow members to receive their benefit before age 55.Members may retire from pension or provident funds subject to certain restrictions in the Income Tax Act.Members may receive their benefits from pension and provident funds when they leave their employer for any reason.These benefits may be transferred to another fund or preservation fund free of tax or the member may take an after-tax cash benefit.
 
Source: By Kieran Godden (TaxTALK)

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