A Fin24 user seeks advice on how to make the most of the tax incentives on his pension fund. He writes:
Can you please explain formula C to me (municipality employee). Can the so-called tax-free portion be invested separately and a tax-free income drawn from it? Or is the tax-free portion capped?
I started work on April 1 1987. I retire in 2017 with R5 000 000. The tax-free portion is about R1 800 000.
Can this portion be invested separately, tax free?
Andries Cilliers, financial planning analyst for senior market advice at Sanlam, responds:
Paragraph 2A will replace Formula C when the final Taxation Laws Amendment Bill is passed by the legislator.
The effect on the taxability of a cash lump sum taken from a public sector fund won’t change.
Only the portion (%) since 1/3/1998 will still be taxed, according to the normal formulae that apply at resignation/retirement from an approved fund.
If we assume that (in your case) the total full service years at retirement in 2017 amount to 30, of which 19 are after 1/3/1998, only 63.333% (i.e. 19 ÷ 30 x 100%) of the cash taken will be subject to tax according to the normal formula.
In other words, 36.666% (i.e. 11 ÷ 30 x 100%) will be tax free (over and above the tax-free portion according to the normal formulae).
If your fund is a pension fund, one-third of the fund value can be taken in cash at retirement. If it is a provident fund, the entire fund value can be taken in cash. Formula C/Para 2A will apply in either case on the cash taken.
If you decide not to take the full one-third (pension fund) or entire fund value (provident fund) in cash, Formula C/Para 2A will still apply, but only on the portion taken in cash.
The net after-tax cash taken may be invested in a discretionary investment of your choice at any institution/product provider of your choice. The taxability of the return of this investment(s) will be determined by the tax laws of the time and products/funds chosen.
We suggest that you contact a qualified financial adviser to assist you in the choice of product funds. He or she will be able to give you expert advice on the tax implications of the specific alternative investment choices.
The two-thirds (pension fund) or portion that you choose not to take in cash (provident fund) must be invested in a compulsory life annuity fund, and the income (pension) taken from the life-annuity fund will be taxed as income in your hands.
There is also a variety of life-annuity fund options and you are, once again, advised to contact a qualified financial adviser to assist you in the choice of products/funds available.
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