The Revenue Laws Amendment Bill, 2008 (the Bill) introduced an amendment to the Income tax Act No.58 of 1962 (the Act) in respect of the taxation of preretirement withdrawals from retirement funds (SARS, 2008:4). Preretirement withdrawal benefits are payable to fund members when they exit the fund prior to retirement or involve payments before termination of membership.
This paper aims at providing a brief overview of the current and proposed legislation as well as a practical illustration of the effect of the current and proposed legislation.
Current legislation
Currently the Act provides for R1 800 of any withdrawal benefit to be exempt from normal taxation (SARS 2008:4). The remaining portion of the lump sum is taxed based on the rating formula of section 5(10) of the Act. This section is also referred to as the averaging section, as it provides for tax to be calculated based on the highest average annual tax rate of the retirement year or the previous year of assessment.
The amount of R1 800 is applied to each year of assessment and not to each lump sum, should more than one fund pay out a withdrawal lump sum in one year of assessment. Consequently, the taxfree portion of R1 800 can be applied each year where a lump sum is paid as a result of withdrawal from a fund. However, paragraph 6 of the Second Schedule of the Act provides for a minimum taxfree portion of the benefit upon withdrawal. This paragraph was amended from 1 March 2006 and results in the taxfree portion (R1 800) being not less than the lesser of:
• the total value of all withdrawal benefits, or
• the sum of the taxpayer’s own contributions to the fund, not allowed as a deduction (Silke 2008:335).
Proposed legislation
The Bill provides that the taxfree portion of preretirement withdrawal benefits be R22 500. Any excess over R22 500 will be taxed according to a separate tax table, which will be included in tax legislation in 2009, while no rebate will be set off against the tax calculated on the lump sum (National Treasury, 2008:6). Therefore, the taxable portion of the lump sum received will be ‘ringfenced’ and taxed separately in accordance with the following table: see Table 1 below.
Table 1
Lump sum: preretirement  Tax liability 
R0 – R22 500  0% 
R22 501 – R600 000  18% 
R600 001 – R900 000  R103 950 + 27% of the amount exceeding R600 001 
R900 001 –  R184 950 + 36% of the amount exceeding R900 001 
This amendment also causes the calculation of normal tax to be simplified, as it eliminates the use of the section 5(10) rating formula. This rating formula is a complex calculation and depends on information that is not generally readily available to the taxpayer or the retirement fund (Tax Brief 2008:1).
Practical illustration
In order to illustrate the effect of both the current and the proposed legislation, an example is provided. For simplicity, all amounts are rounded to the nearest Rand.
Mr. X (50 years old) withdraws (prior to retirement) from a pension fund on 29 February 2008. He receives a lump sum of R300 000 as a result of the withdrawal. Mr. X belonged to the pension fund for 20 years and contributed a percentage of his cash salary throughout this period. Two scenarios are considered. In the first scenario Mr. X contributes 8 percent of his cash salary to the pension fund. In the second scenario he contributes 7.5 percent. In terms of section 11(k) of the Act, a taxpayer may deduct current pension fund contributions limited to a maximum of 7.5 percent of his retirement funding employment (Silke 2008:262). In the case of Mr. X retirement funding employment is his cash salary. His salary was adjusted annually on 1 March. Under both scenarios Mr. X does not transfer any portion of his withdrawal benefit to a qualifying fund. The following table provides information for the 20year period: see Table 2 below.
Table 2
Year of assessment  Cash salary per annum  Contribution per annum at 8%  S.11(k) deduction limited to 7.5%  Nondeductible portion of contribution 
1989  72 000  5 760  5 400  360 
1990  79 200  6 336  5 940  396 
1991  87 120  6 970  6 534  436 
1992  95 832  7 667  7 187  480 
1993  105 415  8 433  7 906  527 
1994  115 957  9 277  8 670  607 
1995  127 552  10 204  9 566  635 
1996  140 308  11 225  10 523  702 
1997  154 338  12 347  11 575  772 
1998  169 772  13 582  12 733  849 
1999  186 750  14 940  14 006  934 
2000  205 424  16 434  15 407  1 027 
2001  225 967  18 077  16 948  1 129 
2002  248 563  19 885  18 642  1 243 
2003  273 420  21 874  20 507  1 367 
2004  300 762  24 061  22 557  1 504 
2005  330 838  26 467  24 813  1 654 
2006  363 922  29 114  27 294  1 820 
2007  400 314  32 025  30 024  2 001 
2008  440 345  35 228  33 026  2 203 
TOTAL  20 646 
Scenario 1 (Mr. X contributes 8 percent of his cash salary to the fund and consequently has a portion of his contributions disallowed):
Position under current legislation
His situation in the 2007 year of assessment is the following:
Salary 400 314
Less: section 11(k) (30 024)
Taxable income 370 290
Tax thereon:
R79 000 + 38% of the amount exceeding R300 000
(PKF 2008:5) 105 710
Less: Primary rebate (Silke 2008:259) ( 7 200)
Normal tax for the year 98 510
Average tax rate: 105 710/370 290 x 100 = 28.5%.
This amount is taxed using the rating formula contained in section 5(10) (Silke 2008:319). This rating formula considers the average rate of taxation of the previous year of assessment and the average tax rate in the current year of assessment. On the assumption that Mr. X only received the salary and could only deduct a section 11(k) deduction for the pension fund contribution, the calculation of his normal tax liability for the 2008 year of assessment would be:
Lump sum received 300 000
Less:
R1 800, but this may not be less than the lesser of the total value of all withdrawal benefits (R300 000) or the sum of all contributions not allowed as a deduction (R20 646). (20 646)
Included in gross income 279 354
Taxable portion of lump sum 279 354
Salary 440 345
Gross income 719 699
Less: Section 11(k) (33 026)
Taxable income 686 673
Tax (Y) according to section 5(10):
Y = {A/[B+D(C+L)] x (BL)} + (LxR)
A = normal tax on [B+D(C+L)] 114 906
B = taxable income 686 673
C = benefits from rescue team or farming 0
D = retirement annuity contributions on lump sum 0
L = lump sum benefit from fund 279 354
R = greater of average tax rate for the current
or the previous year
R, for the 2008 year = 114 906/389 319 = 29.9% 29.9%
R, for the 2007 year = 105 710/370 290 = 28.5%
Therefore:
Y = [114 906/(686 673 – 279 354) x (686 673 – 279 354)] +
(279 354 x 29.9%)
Y = 114 906 + 83 527
Y = 198 433
Less: Primary rebate (Silke 2008:259) ( 7 740)
Normal tax for the year 190 693
Position under proposed legislation
To facilitate comparability the 2008 tax table and rebate is applied to the proposed legislation.
The calculation of Mr. X’s normal tax liability for the 2008 year of assessment would be:
Salary 440 345
Less: Section 11(k) (33 026)
Taxable income 407 319
Tax thereon:
R93 125 + 38% of the amount exceeding R350 000 (PKF 2008:5) 114 906
Less: Primary rebate ( 7 740)
Normal tax (part 1) 107 166
Lump sum received 300 000
Less: exempt portion (22 500)
Taxable portion of lump sum 277 500
Tax thereon: 18% x 277 500 (part 2) 49 950
Summary
Normal tax under current legislation 190 693
Normal tax under proposed legislation (part 1 + part 2) 157 116
This example illustrates that the proposed legislation will be beneficial to the taxpayer to the extent of R190 693 less
R157 116, an amount equal to R33 577.
Scenario 2 (Mr. X contributes 7.5 percent of his cash salary to the fund and consequently has no disallowed portion in terms of section 11(k)):
The taxable portion of the lump sum is calculated as follows:
Lump sum received 300 000
Less: R1 800, but this may not be less than the lesser of the total value of all withdrawal benefits (R300 000) or the sum of all contributions not allowed as a deduction (RNil). ( 1 800)
Included in gross income 298 200
The calculation of his normal tax liability for the 2008 year of assessment would be:
Taxable portion of lump sum 298 200
Salary 440 345
Gross income 738 545
Less: Section 11(k) (33 026)
Taxable income 705 519
Tax (Y) according to section 5(10):
Y = {A/[B+D(C+L)] x (BL)} + (LxR)
A = normal tax on [B+D(C+L)] 114 906
B = taxable income 705 519
C = benefits from rescue team or farming 0
D = retirement annuity contributions on lump sum 0
L = lump sum benefit from fund 298 200
R = greater of average tax rate for the current
or the previous year
R, for the 2008 year = 114 906/407 319 = 28.2% 28.5%
R, for the 2007 year = 105 710/370 290 = 28.5%
Therefore:
Y = [114906/(705 519 – 298 200) x (705 519 – 298 200)] +
(298 200 x 28.5%)
Y = 114 906 + 84 987
Y = 199 893
Less: Primary rebate ( 7 740)
Normal tax for the year 192 153
Summary
Normal tax under current legislation 192 153
Normal tax under proposed legislation 157 116
In this scenario the taxpayer again benefits from the proposed legislation by an amount of R192 153 less R157 116, equal to R35 037.
Conclusion
This paper serves to provide a practical illustration of the effect of the current and proposed tax legislation on withdrawal benefits from retirement funds. It shows that the proposed legislation is indeed beneficial to the taxpayer. In addition, it also simplifies the calculation of the normal tax liability for the taxpayer, as it eliminates the use of the somewhat complex section 5(10) rating formula.
References
1. National Treasury 2008. www.treasury.gov.za. Explanatory memorandum on the Revenue Laws Amendment Bill, 2008 (Submitted to the Portfolio Committee on Finance
22 October 2008).
2. PKF 2008. Tax Guide 2008/2009.
3. Silke on South African Income Tax 2008.
4. South African Revenue Services (SARS) 2008.
www.sars.gov.za. Draft explanatory memorandum on the Revenue Laws Amendment Bill, 2008.
Ellané van Wyk CA(SA), MAcc is a tax lecturer at the University of Stellenbosch.
This paper aims at providing a brief overview of the current and proposed legislation as well as a practical illustration of the effect of the current and proposed legislation.
Current legislation
Currently the Act provides for R1 800 of any withdrawal benefit to be exempt from normal taxation (SARS 2008:4). The remaining portion of the lump sum is taxed based on the rating formula of section 5(10) of the Act. This section is also referred to as the averaging section, as it provides for tax to be calculated based on the highest average annual tax rate of the retirement year or the previous year of assessment.
The amount of R1 800 is applied to each year of assessment and not to each lump sum, should more than one fund pay out a withdrawal lump sum in one year of assessment. Consequently, the taxfree portion of R1 800 can be applied each year where a lump sum is paid as a result of withdrawal from a fund. However, paragraph 6 of the Second Schedule of the Act provides for a minimum taxfree portion of the benefit upon withdrawal. This paragraph was amended from 1 March 2006 and results in the taxfree portion (R1 800) being not less than the lesser of:
 the total value of all withdrawal benefits, or
 the sum of the taxpayer’s own contributions to the fund, not allowed as a deduction (Silke 2008:335).
Proposed legislation
The Bill provides that the taxfree portion of preretirement withdrawal benefits be R22 500. Any excess over R22 500 will be taxed according to a separate tax table, which will be included in tax legislation in 2009, while no rebate will be set off against the tax calculated on the lump sum (National Treasury, 2008:6). Therefore, the taxable portion of the lump sum received will be ‘ringfenced’ and taxed separately in accordance with the following table: see Table 1 below.
Table 1
Lump sum: preretirement
 Tax liability

R0 – R22 500
 0%

R22 501 – R600 000
 18%

R600 001 – R900 000
 R103 950 + 27% of the amount exceeding R600 001

R900 001 –
 R184 950 + 36% of the amount exceeding R900 001

This amendment also causes the calculation of normal tax to be simplified, as it eliminates the use of the section 5(10) rating formula. This rating formula is a complex calculation and depends on information that is not generally readily available to the taxpayer or the retirement fund (Tax Brief 2008:1).
Practical illustration
In order to illustrate the effect of both the current and the proposed legislation, an example is provided. For simplicity, all amounts are rounded to the nearest Rand.
Mr. X (50 years old) withdraws (prior to retirement) from a pension fund on 29 February 2008. He receives a lump sum of R300 000 as a result of the withdrawal. Mr. X belonged to the pension fund for 20 years and contributed a percentage of his cash salary throughout this period. Two scenarios are considered. In the first scenario Mr. X contributes 8 percent of his cash salary to the pension fund. In the second scenario he contributes 7.5 percent. In terms of section 11(k) of the Act, a taxpayer may deduct current pension fund contributions limited to a maximum of 7.5 percent of his retirement funding employment (Silke 2008:262). In the case of Mr. X retirement funding employment is his cash salary. His salary was adjusted annually on 1 March. Under both scenarios Mr. X does not transfer any portion of his withdrawal benefit to a qualifying fund. The following table provides information for the 20year period: see Table 2 below.
Table 2
Year of assessment
 Cash salary per annum
 Contribution per annum at 8%
 S.11(k) deduction limited to 7.5%
 Nondeductible portion of contribution

1989
 72 000
 5 760
 5 400
 360

1990
 79 200
 6 336
 5 940
 396

1991
 87 120
 6 970
 6 534
 436

1992
 95 832
 7 667
 7 187
 480

1993
 105 415
 8 433
 7 906
 527

1994
 115 957
 9 277
 8 670
 607

1995
 127 552
 10 204
 9 566
 635

1996
 140 308
 11 225
 10 523
 702

1997
 154 338
 12 347
 11 575
 772

1998
 169 772
 13 582
 12 733
 849

1999
 186 750
 14 940
 14 006
 934

2000
 205 424
 16 434
 15 407
 1 027

2001
 225 967
 18 077
 16 948
 1 129

2002
 248 563
 19 885
 18 642
 1 243

2003
 273 420
 21 874
 20 507
 1 367

2004
 300 762
 24 061
 22 557
 1 504

2005
 330 838
 26 467
 24 813
 1 654

2006
 363 922
 29 114
 27 294
 1 820

2007
 400 314
 32 025
 30 024
 2 001

2008
 440 345
 35 228
 33 026
 2 203

TOTAL
 20 646

Scenario 1 (Mr. X contributes 8 percent of his cash salary to the fund and consequently has a portion of his contributions disallowed):
Position under current legislation
His situation in the 2007 year of assessment is the following:
Salary 400 314
Less: section 11(k) (30 024)
Taxable income 370 290
Tax thereon:
R79 000 + 38% of the amount exceeding R300 000
(PKF 2008:5) 105 710
Less: Primary rebate (Silke 2008:259) ( 7 200)
Normal tax for the year 98 510
Average tax rate: 105 710/370 290 x 100 = 28.5%.
This amount is taxed using the rating formula contained in section 5(10) (Silke 2008:319). This rating formula considers the average rate of taxation of the previous year of assessment and the average tax rate in the current year of assessment. On the assumption that Mr. X only received the salary and could only deduct a section 11(k) deduction for the pension fund contribution, the calculation of his normal tax liability for the 2008 year of assessment would be:
Lump sum received 300 000
Less:
R1 800, but this may not be less than the lesser of the total value of all withdrawal benefits (R300 000) or the sum of all contributions not allowed as a deduction (R20 646). (20 646)
Included in gross income 279 354
Taxable portion of lump sum 279 354
Salary 440 345
Gross income 719 699
Less: Section 11(k) (33 026)
Taxable income 686 673
Tax (Y) according to section 5(10):
Y = {A/[B+D(C+L)] x (BL)} + (LxR)
A = normal tax on [B+D(C+L)] 114 906
B = taxable income 686 673
C = benefits from rescue team or farming 0
D = retirement annuity contributions on lump sum 0
L = lump sum benefit from fund 279 354
R = greater of average tax rate for the current
or the previous year
R, for the 2008 year = 114 906/389 319 = 29.9% 29.9%
R, for the 2007 year = 105 710/370 290 = 28.5%
Therefore:
Y = [114 906/(686 673 – 279 354) x (686 673 – 279 354)] +
(279 354 x 29.9%)
Y = 114 906 + 83 527
Y = 198 433
Less: Primary rebate (Silke 2008:259) ( 7 740)
Normal tax for the year 190 693
Position under proposed legislation
To facilitate comparability the 2008 tax table and rebate is applied to the proposed legislation.
The calculation of Mr. X’s normal tax liability for the 2008 year of assessment would be:
Salary 440 345
Less: Section 11(k) (33 026)
Taxable income 407 319
Tax thereon:
R93 125 + 38% of the amount exceeding R350 000 (PKF 2008:5) 114 906
Less: Primary rebate ( 7 740)
Normal tax (part 1) 107 166
Lump sum received 300 000
Less: exempt portion (22 500)
Taxable portion of lump sum 277 500
Tax thereon: 18% x 277 500 (part 2) 49 950
Summary
Normal tax under current legislation 190 693
Normal tax under proposed legislation (part 1 + part 2) 157 116
This example illustrates that the proposed legislation will be beneficial to the taxpayer to the extent of R190 693 less
R157 116, an amount equal to R33 577.
Scenario 2 (Mr. X contributes 7.5 percent of his cash salary to the fund and consequently has no disallowed portion in terms of section 11(k)):
The taxable portion of the lump sum is calculated as follows:
Lump sum received 300 000
Less: R1 800, but this may not be less than the lesser of the total value of all withdrawal benefits (R300 000) or the sum of all contributions not allowed as a deduction (RNil). ( 1 800)
Included in gross income 298 200
The calculation of his normal tax liability for the 2008 year of assessment would be:
Taxable portion of lump sum 298 200
Salary 440 345
Gross income 738 545
Less: Section 11(k) (33 026)
Taxable income 705 519
Tax (Y) according to section 5(10):
Y = {A/[B+D(C+L)] x (BL)} + (LxR)
A = normal tax on [B+D(C+L)] 114 906
B = taxable income 705 519
C = benefits from rescue team or farming 0
D = retirement annuity contributions on lump sum 0
L = lump sum benefit from fund 298 200
R = greater of average tax rate for the current
or the previous year
R, for the 2008 year = 114 906/407 319 = 28.2% 28.5%
R, for the 2007 year = 105 710/370 290 = 28.5%
Therefore:
Y = [114906/(705 519 – 298 200) x (705 519 – 298 200)] +
(298 200 x 28.5%)
Y = 114 906 + 84 987
Y = 199 893
Less: Primary rebate ( 7 740)
Normal tax for the year 192 153
Summary
Normal tax under current legislation 192 153
Normal tax under proposed legislation 157 116
In this scenario the taxpayer again benefits from the proposed legislation by an amount of R192 153 less R157 116, equal to R35 037.
Conclusion
This paper serves to provide a practical illustration of the effect of the current and proposed tax legislation on withdrawal benefits from retirement funds. It shows that the proposed legislation is indeed beneficial to the taxpayer. In addition, it also simplifies the calculation of the normal tax liability for the taxpayer, as it eliminates the use of the somewhat complex section 5(10) rating formula.
References
 National Treasury 2008. www.treasury.gov.za. Explanatory memorandum on the Revenue Laws Amendment Bill, 2008 (Submitted to the Portfolio Committee on Finance
22 October 2008).  PKF 2008. Tax Guide 2008/2009.
 Silke on South African Income Tax 2008.
 South African Revenue Services (SARS) 2008.
www.sars.gov.za. Draft explanatory memorandum on the Revenue Laws Amendment Bill, 2008.
Ellané van Wyk CA(SA), MAcc is a tax lecturer at the University of Stellenbosch.