IS YOUR RETRENCHMENT PACKAGE TAXABLE?

So twice in the past month I’ve gotten a call from clients about the same thing – retrenchment.

The first person was in the process of being retrenched and she wanted to know how much she’d get out after tax. The second person had already been retrenched and was calling to follow up on a retrenchment claim she’d submitted on her policy.

There’s no question that as a country, we’re heading into treacherous waters. Businesses are struggling, and struggling companies means retrenchment which means struggling people.

More of this is going to be happening as time goes by, so it helps to know what to do beforehand. And don’t think you can quickly take out retrenchment cover if you’re being retrenched – a few requirements must be first met.

How much of your retrenchment package goes to the taxman?

Let’s find out in 3 easy steps, but first I’m going to assume:

  • you haven’t retired and withdrawn a lumpsum after March 2009, or
  • had severance benefits paid to you after March 2011.

That’s because the above benefits are included in the calculation below, and I want to keep things simple.

Step 1:

So any amount you receive in the form of a retrenchment package is included in your gross income. I hear you saying, “It’s not a monthly salary, it’s a cash lumpsum; how can they include it as income?

Hang on, it’s not as bad as you think, but imagine losing your job and having to pay tax on a R100, 000 retrenchment package. That would bang you right up into the 41% tax bracket.

Fortunately it doesn’t quite work like that.

Step 2:

The following payments are all excluded from taxable income:

  • Retirement fund lump sums
  • Withdrawal benefits
  • Severance benefits forming part of a retrenchment package

The three items mentioned above are taxed according to their very own table:

Taxable portion of lump sum Rate of tax
R0 – R500 000 0%
R500 001 – R700 000 18% of the amount exceeding R500 000
R700 001 – R1 050 000 R36 000 + 27% of the amount exceeding R700 000
R1 050 000 and more R130 500 + 36% of the amount exceeding R1 050 000

 Step 3:

Now you need to decide whether you wish to withdraw from your pension or provident fund or to preserve these benefits for retirement. Your retirement fund and your severance package aren’t the same thing, but both qualify for the tax break. If you’re not of retirement age, then it’s best to preserve your retirement fund.

But you need to know that this is a once off allowance.

What do I mean by that? Well let’s say you take the R500, 000 tax-free amount at retrenchment. Ten years later you decide to retire. At that point you would not be allowed to take a further R500, 000 out tax-free. In other words it’s a once off allowance.

So here’s the conundrum you face

Cashing in your retirement fund is plain silly. If you think it’s tough now, wait until retirement. Rather preserve your retirement fund for the day you need it. After all, when you retire, you’ll still have access to whatever’s left of your R500, 000 tax-free amount.
In the meantime you could use some of the R500, 000 tax-free amount with your severance package.

On the other hand, you now have an opportunity – before retirement – to get your hands on R500, 000 of your retirement fund without paying the tax on it. If you ignore this opportunity – and decide later to withdraw once-off before retirement – you won’t get the R500, 000 paid out tax-free.

Let’s face it, R500, 000 tax-free in your pocket today is worth a lot more than R500, 000 in your pocket in ten years’ time (unless our government increases the tax-free amount in the coming years).

It all depends on how close you are to actual retirement.
If you’re close to retirement, and your combined retirement fund/severance package fits nicely into the R500, 000 tax-free bracket, then it might make sense to withdraw at retrenchment.

Let me give you an example…

Sally is almost 60. She has R600, 000 in her pension fund.

If she waits until retirement then the situation looks like this:

  • One-third of her pension fund may be taken in cash – R200, 000
  • Of that, the full R200, 000 would pay out tax-free since she is allowed up to R500, 000.
  • The remaining two-thirds would be used to buy her a taxable annuity income.

Lots of tax in that scenario, and the remainder of the R500, 000 is an opportunity lost.

If she took the retrenchment package:

  • R500, 000 could be taken in cash tax-free and invested until age 60.
  • The remaining R100, 000 could be invested in a pension preservation fund until 60
  • At 60, the R100, 000 is used to purchase a taxable annuity income

Much less tax in this scenario, you agree?

My advice is to chat with your financial advisor before making a decision. Let them consider a few scenarios so that you can make an informed decision.

But I’d also suggest taking out retrenchment cover while you can.

I’ve just had a client retrenched after 15 years of service. Just last year she took out a policy for R100, 000 (R20, 000 a month x 5 months paid as a lumpsum).

Three weeks ago she was paid out her R100 , 000. If she happens to find a new job in the next month, that’s great because she’s got her money. Some insurance companies only pay the monthly amount, in this case R20, 000, for the period unemployed. Find a job in month two and the income stops.

Interested?

The requirement is usually something like this:

  • You need to be employed on a full time basis for the past two years,
  • of which the last year must be with the employer who retrenched you.

If that’s you, and you’re keen on getting a quote from me, fill your details in below.

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The InsuranceFundi Team

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2 thoughts on “IS YOUR RETRENCHMENT PACKAGE TAXABLE?

  1. Do you have to add your retrenchment package and your pension fund payout together, or is there a separate up-to-R500 000 tax break on each one?

    • Hi Alison,

      Both are used in the same calculation. It’s not R500, 000 each, but R500, 000 in total