Two pots will add complexity to the tax treatment of retirement benefit withdrawals

National Treasury and the South African Revenue Service (Sars) have introduced many changes to the tax treatment of South African retirement vehicles that have often resulted in adverse implications and penalties for early withdrawals, or the application of strict rules and regulations. The aim was to incentivise South Africans to be more forward thinking and to encourage the provisioning of adequate savings for retirement.

To understand the new path charted by National Treasury for retirement vehicles, we first must take a stroll through the genesis of the changes made over time:

Previously, the three types of retirement funds (pension, provident and retirement annuity) had different caps and deduction bases applied to them. In an effort to harmonise the tax treatment of these different types of funds, from 1 March 2016, the legislation was amended to allow for a 27.5% tax deduction, up to R350 000 a year, for all retirement fund contributions.

In March 2021, an amendment was enacted that required those who are retiring to purchase an annuity with a portion of their pension or provident fund interest. This further evidenced Treasury’s attempt to create uniformity among these retirement vehicles. However, there were still restrictions in terms of the annuities that could be acquired upon retirement.

For taxpayers who emigrate, a three-year lock-in period on all retirement funds was introduced before expatriates could withdraw their retirement interests. Previously, individuals ceasing tax residency in South Africa (that is, undergoing a residency cessation/financial emigration process) could withdraw their retirement funds, in full, upon the formalisation of their residency cessation.

With effect from 1 March 2021, their retirement benefits were locked in for a minimum of three years, after which they could be fully withdrawn (subject to lump-sum tax implications). Simply put, one must have been a non-resident for a minimum of three years, as confirmed by Sars, before one could qualify to withdraw one’s retirement interest in full.

The resultant requirements for withdrawing locked-in retirement benefits included the furnishing of a Tax Clearance Status (TCS) PIN, issued by Sars, to access the funds and withdraw them. However, the PIN would expire after 12 months. Recently, and after the controversial Sars tax residency status “reset”, a Sars-issued Notice of Non-resident Tax Status Letter has become an important requirement as well – this letter has no expiration date.

In March 2022, the Taxation Laws Amendment Act (TLAA) increased the flexibility for a retiring member by expanding the types of annuities a member can purchase upon retirement, thereby allowing the use of retirement interests to acquire annuities.

Further targeted at those ceasing tax residency, a proposal was suggested to implement a tax levy on the retirement interests of individuals upon the cessation of their South African tax residency. After vehement opposition by industry stakeholders and the Expat Tax Petition group, this proposal was scrapped, which was confirmed with the promulgation of the TLAA.

As expected, each of these changes has created difficulties for South Africans (including expatriates). South Africans were still unable to access their funds without adverse tax and penalty implications, and many of those who required urgent access to these funds sacrificed their employment and, ultimately, their retirement security.

Expatriates subjected to the three-year lock-in period are no longer able to utilise their funds to assist with the financial hardship associated with emigration and their new ventures and would still fall within the South African tax net, post-emigration.

In a continuous effort to strike a balance between individual financial hardships and the need to maximise savings for retirement, a revamp of retirement benefits was proposed to the public for comment.

New pots on the block

In December 2021, the government published a discussion document proposing a new retirement regime that aims to improve the lack of provision for retirement and alleviate the financial distress of households that have assets encumbered in their retirement benefits.

With effect from 1 March 2024, fund administrators will create a “retirement pot” and a “savings pot”, each of which can receive retirement contributions.

All prior contributions and related growth will have to be valued on 28 February 2024 to enable the vesting of rights, and a “vested pot” will be created to accommodate these into the new system. To give effect to this, new proposed definitions are to be included in section 1(1) of the Income Tax Act. Among other legislative amendments accommodating this change, access to the savings pot will be allowed once, during any 12-month period, and a minimum of R2 000 must be withdrawn if a savings withdrawal is made.

The two-pot retirement system comes with new tax treatment proposals, which fall shy of creating the uniformity it seeks. Simply put, withdrawals from the vested pot will be taxed in accordance with the pre-1 March 2024 tax provisions. All annual withdrawals from the savings pot will be included in an individual’s gross income and taxed at their marginal income tax rate. The retirement pot will be locked in until retirement and will be taxed in accordance with the lump-sum withdrawal table.

So, where to from here?

As commendable as National Treasury’s attempt to consolidate the position on retirement benefits is, the two-pot system adds immense complexity to the tax treatment of policy withdrawals.

For expatriates who have ceased South African tax residency before the enactment of this system, or have done so after the enactment, or who plan to cease their tax residency, it has now become a requirement to acquire both the Notice of Non-resident Tax Status Letter and the TCS PIN before the amounts may be released and sent abroad.

Although, with the new proposition, these will still be important requirements, the complexity of the tax treatment of retirement interests suggests that consultation with experts is necessary to ensure a smooth, efficient and compliant approach is taken in each case.

Khutso Makgoka is a specialist legal consultant: expatriate tax and Megan Tucker is a processing supervisor at Tax Consulting SA.

Disclaimer: This article is published purely for informational purposes and does not constitute financial or legal advice.