Retirement tax surprise for South Africans

Some South Africans who withdraw funds from their retirement savings under the new two-pot system are in for a nasty tax surprise as the withdrawal may push them into a higher tax bracket. 

South Africa’s new two-pot retirement system has been in effect for just over three weeks, enabling individuals to withdraw billions from their savings pots. 

The new system splits retirement contributions into two ‘pots’, with two-thirds going towards a retirement pot and one-third going to a savings pot. 

The retirement pot has to remain invested until retirement when it can be used to purchase a living annuity or other retirement product. 

Much of the focus has been on the savings pot, which South Africans can withdraw money from once every tax year to cover emergency expenses. 

As part of this, many asset managers have warned that early withdrawals may also have significant tax implications as they are taxed at your marginal tax rate. 

Your financial services company currently asks for a tax directive when you request a two-pot withdrawal. 

SARS then tells them what percentage of the amount to pay over to them and, on top of that, to deduct any money they owe the government. 

However, actuarial specialist Paul Menge at Momentum Investments said there is a nasty tax surprise that individuals may be unaware of.

This has to do with your income bracket. The tax rate we normally pay, the so-called marginal rate, is based on an income bracket or range. 

If your current income is close to the top level of the bracket, your investment income from your two-pot withdrawal can push you over that level into a higher tax bracket. 

You can also be pushed into a higher bracket if you get a salary increase at any time during the tax year. Or another windfall. Sometimes, it will be the combination of a two-pot withdrawal plus your increase that can push you to a higher bracket.

This could lead to a significantly higher tax burden for some South Africans tapping into the two-pot system. 

When it’s time for your yearly tax assessment towards July, SARS will look at your total yearly income, determine your tax bracket, and claim tax from you based on the full picture.

Menge explained that it is best to realise that you may have to pay more tax on the amount in the higher bracket if you withdraw from the two-pot and receive a higher income. 

The concern regarding this is that if you didn’t pay the higher tax when the withdrawal was made, you will have to repay this when you submit your annual tax assessment. 

If you cannot afford it at the time and have to make another two-pot withdrawal to pay SARS, it can result in a cycle where you keep paying more tax than you had anticipated.

Menge also provided a useful example to remind individuals just how much tax they will pay on a two-pot withdrawal.

Let’s say Peter earns a taxable yearly income of R600,000 or R50,000 per month – this means he pays a marginal tax rate of 36%. 

He has R150,000 saved up in his retirement annuity and wants to withdraw R15,000. SARS will indicate that he must pay R5,400 tax. If the withdrawal fee is R200, he will receive only R9,400 in his pocket.

Thus, Menge said, in most cases, it is not worth it to withdraw from your retirement fund early unless it is a genuine emergency. 

Not only will it negatively affect your outcome in retirement, but it will not have the desired effect in the short term. 

Menge said that if you are in trouble and absolutely need to use your retirement savings, maybe the painful payment to SARS will encourage individuals to start building an emergency savings fund. 

Early withdrawals also have the potential to have negative consequences for South Africa’s long-term economic growth. 

Much of the estimated R4 billion withdrawn in the first two weeks of the new system is expected to flow into consumer spending on discretionary products such as clothing and household goods. 

Little is expected to be used to pay off debt or meet an emergency expense. 

Increased spending in the next year will be offset by declining savings and a smaller pool of capital to fund investments in South Africa.