IS YOUR RETRENCHMENT PACKAGE TAX-FREE?

You’re not quite ready for retirement and you’re about to be retrenched. How will you be taxed?

Business had been bad for a few years now.
As Rob looked around the office, he remembered the various names and faces who had sat at each of the empty desks. But Rob was comfortable, much like the frog in a pot of water warming on the stove.

But the inevitable was about to happen.

Rob received an email from HR with a meeting request. Rob had a feeling something wasn’t right.

The meeting went something like this:

HR: “Hi Rob, good to see you. It’s been a long time but how you keeping?”
Rob: “Good, good, can’t complain, and you?”
HR: “All good, can’t complain. Listen Rob, I have some bad news. As you know sales are down, and they’re pulling the plug on the operation. I’m sorry to be the one to tell you, but you’re being retrenched. It’s not all bad news. You’ve been here for donkey’s years, and we’re offering a week’s wages for every year you’ve been here.”
Rob: “I don’t know what to say. Where am I going to find work now? I’m 52 this year.”
HR: “I’m sorry Rob. What can I say? Times are tough.”

As Rob drives away panic sets in. What am I going to tell my wife? What am I going to do? What if I don’t find another job ever again?

First things first…

Let’s start off by saying that a severance benefit does not include your retirement fund lumpsum. We often hear people say: “I’ve been offered a retrenchment package which includes my provident fund…”

The severance benefit is a separate amount received from your employer to compensate you for the loss of your job. Don’t confuse your pension and provident fund with your retrenchment package.

Your pension or provident fund belongs to you regardless of retrenchment, resignation or retirement. The good news, from a tax point of view, is that you are entitled to withdraw from your retirement fund at retrenchment and enjoy the same tax deduction which is explained below.

But before we run away from severance benefits –

  • It does not include your accumulated leave pay, bonuses, commissions, overtime, and travel allowances.
  • Nor do you qualify for a retrenchment package if you own more than 5% of the shares in the company.

Second thing you need to know…

A retrenchment package forms part of your gross income. In other words, it appears on the radar at SARS.

Taxable Income

However, taxable income excludes:

  • Retirement fund lump sums
  • Withdrawal benefits, and
  • Severance (Retrenchment) benefits

These benefits are taxed according to their own table as follows:

Taxable Income – 2017 Rate of Tax – 2017
R0 – R500 000 0% of taxable income
R500 001 – R700 000 18% of taxable income above R500 000
R700 001 – R1 050 000 R36 000 + 27% of taxable income above R700 000
R1 050 001 and above R130 500 + 36% of taxable income above R1 050 000

What this is saying, is that the taxable portion of any lumpsum paid to you from:

  • A pension fund,
  • A provident fund,
  • A retirement annuity (only applies upon retirement or death), or
  • Severance benefits

Is taxed according to the abovementioned table

How does this work in practise?

What happens is:

  • All your lumpsum benefits get added together.
  • From this they deduct any contributions made by you to a pension or provident fund which were not tax deductible previously (These contributions must in any case pay out to you tax-free since they weren’t tax deductible in the first place).
  • Then they add to the sum any taxable portions of lump sums received in the past. In other words, if you’ve already made use of the tax-free lumpsum portion in the past, then that previous withdrawal reduces the current tax-free portion available to you.
  • Then they apply the table above to that lumpsum amount.

Getting back to Rob now

Rob has the following benefits available:

  • Retrenchment package being offered – R50, 000
  • Pension fundR250, 000, and
  • Provident fundR250, 000

Rob's Retrenchment Package

All in all, he has R550, 000. He decides to cash it all in in since he plans on emigrating (Cashing in your retirement monies is never a great idea, by the way).

The tax-free portion works something like this:

  • Retrenchment packageR50, 000
  • Pension fundR200, 000, and
  • Provident fundR250, 000

There’s the R500, 000 tax-free amount done and dusted.

Now on to the R50, 000 which remains:

  • Pension fund – R50, 000 x 18% = R9, 000 tax owed to SARS

Conclusion

If Rob had approached us for advice we would have recommended only withdrawing the retrenchment benefit.

Rob could have transferred his pension and provident fund into either:

  • A preservation fund, or
  • A retirement annuity

This would have happened tax-free anyway. Once Rob formally retired, he could then take the balance of his tax-free portion as follows:

  • R500, 000 is the original tax-free portion he had available at retrenchment
  • R50, 000 is the benefit taken previously at retrenchment
  • R450, 000 is the tax-free balance still available at retirement
  • The balance exceeding the R450, 000 is taxed according to the retirement fund lumpsum benefit table

Of course, one might argue that the R500, 000 tax-free amount is worth very little ten years from now, and therefore decide to cash in while they can, but that a whole other topic.

Are you facing retrenchment and in need of assistance? Click here and drop us a mail.

Until next time.

The InsuranceFundi Team

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6 thoughts on “IS YOUR RETRENCHMENT PACKAGE TAX-FREE?

  1. This article is totally wrong as you would get taxed at the withdrawal tables for the pension and provident fund not the retirement table that is used above….the R500,000 tax free will only apply to severance money before 55 and pension / provident money you take as a lump sum once you retire…. if you withdraw pension or provident money before 55 only the 1st R25,000 is tax free….

    • The article is correct. I was also under the same impression as you are, but it’s not true.

      National Treasury decided in 2008 to tax withdrawal benefits received by members which were triggered by retrenchment in terms of the special rates applicable to retirement fund lump sums (even though it is, in essence, a pre-retirement lump sum). This is the reason why the paragraph 6 deductions (and not the Paragraph 5 deductions) reduce these lump sum benefits.

      Source document: Silke tax

    • The retrenchment package is usually determined by the number of years you have been employed at your employer. In other words, there is only an employer contribution. Don’t get this confused with your pension or provident fund contributions.

  2. DOES YOUR RETRENCHMENT PACKAGE AND PROVIDENT FUND GET ADDED TO SARS RETURN FOR THAT SPECIFIC YEAR? THIS PUSH YOU AUTOMATICLY INTO A HIGHER TAX BRACKET, YOU THEN GET TAXED ON THIS EVEN IF THE TAX ON PROVIDENT WAS 0% AT TIME OF RECEIVING IT, THIS MEANS YOU PAY IN THE LONG RUN. RIGHT

    • Your retrenchment package does not form part of your income for the tax year, and won’t push you into a higher tax rate. It is taxed according to a separate table.