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Introduction

Individuals do not work for one employer until they retire these days anymore. Irrespective of whether you resign for a better opportunity, take an early package or your employer’s retirement fund is dissolved (‘exit events’) you have to decide what to do with your fund benefits which become available from the fund.

Most individuals take the fund benefit which becomes available with an exit event as a cash payout and use it in their everyday life without considering all the implications of their decisions.

You have the following options when an exit event occurs:

  1. You can withdraw it as a lump sum payout:
    Any withdrawal larger than R25,000 is taxed at fixed rates. Also refer to the discussion later in this document for the very negative tax consequences for your current situation, as well as for the future, if you should make a withdrawal now.
  2. You can transfer the retirement benefits to your new employer’s retirement fund:
    This can only be done if you immediately start at your new employer after you left your previous employment. This option also do not give you access to your retirement benefits before you become 55 or you leave your new empolyer’s retirement fund.
  3.  You can transfer the fund benefits to a Retirement Annuity (‘RA’):
    The fund benefits are preserved without any negative tax effects, but again you can only get access  to the funds when you become 55. RAs do not offer the potential once-off withdrawal option that preservation funds offer.
  4. You can transfer the fund benefits to a Preservation Fund:
    The fund benefits are once again preserved without any negative tax effects. You have the option to make one lump sum withdrawal before you are 55. However, you will again be taxed at the fixed rates for any withdrawal that exceeds R22,500 when you make a withdrawal in future.
  5. You can transfer a part of the fund benefits to a Preservation Fund and a part to a RA:
    This combination offers potential tax savings in the year that you resign as well as the once-off withdrawal option that preservation funds offer.

Characteristics of preservation funds

A preservation fund is a pension fund or provident fund that is registered with the Registrar of Pension Funds and is approved by SARS. These funds are designed to be a temporary parking bay for withdrawal benefits from registered and approved pension and provident funds.

A member's accumulated benefit in a specific pension fund or provident fund may not be transferred to more than one preservation fund, but the benefits can be split between a preservation fund and a RA fund.

Only transfers from an employer's pension fund to a preservation pension fund and from an employer's provident fund to a preservation provident fund is allowed.

Transfers from pension funds or provident funds may only be transferred when an exit event has occured.

Transfers from preservation funds to RA funds are not allowed.

You cannot make any additional contributions to an existing preservation fund. If you already have a preservation fund in place as a result of a previous transfer you cannot add to this specific fund. A new preservation fund plan has to be put in place.

You may only make one withdrawal from a preservation fund before retirement. This withdrawal may be a portion of or the whole of the fund. It will be taxed at predetermined rates.

As with most retirement funds you cannot take a loan against a preservation fund and a preservation fund cannot serve as security for any loan.

A preservation fund is protected against claims of creditors if you should be sequestrated.

Preservation funds are provided by insurance companies or linked investment service providers ('LISPS'). LISPS offer a variety of investment choices and the ability to review the portfolio on a recurring basis.

Most of the underlying investments in unit trust funds is compiled by investment specialists and is based on your risk profile. The security of your capital therefore depends on the investment choices that you make. You can therefore lose a portion of or all your capital if you invest in a market-related product.

When you retire the capital in your preservation fund is taxed in exactly the same way as any other retirement fund. For example, if you are invested in a preservation fund you have to use two thirds of the fund value to purchase a pension. You are not obliged to purchase a pension at any specific company and you should contact us if you are considering the purchase of a pension.

Sometimes, after your funds have already been transferred to your preservation fund, surplus funds or interest become available from the same pension or provident fund (transferring fund). These additional "contributions" are then added to your existing preservation fund.

Negative tax consequences when fund benefits are withdrawn

Amount

Rate

R0 to R25,000

0%

R25,001 to R660,000

18%

R660,001 to R990,000

27%

More than R990,001

36%

Illustrative example – Mr Informed

Mr Informed is 35 years old and he resigns at his employer where he has worked since the start of his career. The fund value of his retirement fund is R500,000 and he decides to place the entire amount on a Preservation Fund.

There is NO negative tax consequences with regards to this decision, and the total amount of R500,000 is invested on his behalf.

He retires at age 60 and the fund value of his Preservation Fund at that stage is R5,417,352 (at an average annual return of 10% per year over the period). He can then withdraw one third tax free as a lump sum and implement a pension with the remainder of his fund value.

Illustrative example – Mr Selfwise

Mr Selfwise is 35 years old and he resigns at his employer where he has worked since the start of his career. The fund value of his retirement fund is R500,000 and he decides to withdraw the total amount and use it for discretionary purposes.

Income tax of R85,950 will be deducted automatically from the R500,000 at predetermined rates, and a net amount of R414,050 will be paid out to him.

In addition to these negative tax consequences this withdrawal will be taken into account with the amount that Mr Selfwise can withdraw tax free as a lump sum at retirement. He will then not be able to take any tax free lump sum at retirement and he is penalised double for this withdrawal that he made before retirement.

Conclusion

Due to these extremely negative consequences of a withdrawal we recommend that individuals should preserve their fund benefits for retirement, and not use it for other purposes. When you have made a choice it cannot be reversed, and it is therefore crucial to exercise the right choices throughout your life.

There are other factors as well to consider when an exit event occurs and we recommend that you contact us as soon as it happens so that we can advise you over the implications of your decisions.