Calculating the Taxable Portion of a Compulsory Annuity
16 July 2013
Posted by: Author: Doné Howell
Author: Doné Howell (Grant Thornton)
The 2013 budget speech made mention again of the various retirement reforms proposed by National Treasury. As part of these reforms, or perhaps a fortuitous coincidence, a long-standing inequity in the tax legislation will be corrected from the 2015 tax year.
The inequity referred to lies in the differing tax treatment of retirement interest upon retirement from a pension, pension preservation fund or retirement annuity fund (‘retirement fund’), depending on whether payment is in the form of a lump sum or in the form of a compulsory annuity (‘annuity’).
When you retire, you may either take your retirement interest as a lump sum (maximum of one-third), leaving two-thirds to be used to purchase an annuity, or you may use the full amount to purchase an annuity.
If you select the one-third lump sum payment, the value of the taxable portion can be reduced by an amount equal to the value of all the contributions made to your retirement fund, which were previously not allowed as a tax deductions (‘non-deductible contributions’). However, this applies only when a lump sum payment is chosen and is not available to those who select an annuity.
Now, with the introduction of section 10C – ‘exemption of non-deductible element of compulsory annuities’, this inequity will disappear for all amounts received on or after 1 March 2014. Essentially, it will allow all non-deductible contributions, irrespective of the retirement fund to which the contributions were made, to be pooled, which will be applied on a first-come-first served basis against any lump sum or annuity.
For illustration purposes we include the example to the SARS explanatory memorandum:
- Facts: Mr X belongs to a pension fund. He has R200 000 in non-deductible contributions accumulated when he retires from the fund. He decides not to take a lump sum, and acquires a guaranteed life annuity with the R1 000 000 retirement interest at retirement.
- Results: The first R200 000 received in annuity payments from the living annuity will be exempt from income tax.
It is unclear why SARS did not take this opportunity to address another and far greater inequity between a lump sum and an annuity. We are broadly referring to the fact that at retirement, the first R315 000 of a lump sum is tax-free and the balance is taxed at favourable tax rates. In contrast however, annuities are taxed in full, at marginal tax rates. Nevertheless, the option to claim the non-deductible contributions against an annuity will benefit many retirees and is definitely a step in the right direction!