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.