If you’ve recently been retrenched or lost your job, you may be contemplating moving your retirement fund benefits into a preservation fund. However, before doing so, it is important to understand exactly how preservation funds work.
What is a preservation fund?
A preservation fund is a retirement fund and, as such, falls within the auspices of the Pension Funds Act and the Income Tax Act. The primary purpose of a preservation fund is to house and preserve the proceeds of a pension or provident fund where a person has been retrenched or dismissed, or where he has resigned from his employ. Proceeds transferred from a pension fund must be transferred to a pension preservation fund, while proceeds from a provident fund must be transferred to a provident preservation fund. It is not possible to withdraw a portion of your retirement fund and invest the balance into a preservation fund. In other words, if you choose to preserve your capital you are required to transfer the full amount into a preservation fund.
What are the tax implications of transferring to a preservation fund?
If you move your retirement benefit from a pension or provident fund directly into a preservation fund, there will be no tax consequences, making preservation funds tax-effective investment vehicles. Further, you will not be taxed on the investment returns achieved in the preservation fund. Also, funds invested in a preservation fund fall outside of your estate and are therefore exempt from estate duty. You will only be taxed if you withdraw from your preservation fund, with the first R25 000 being tax-free.
Can I make additional contributions to my preservation fund?
No, you cannot make any additional contributions to your preservation fund once you have set it up which means that your investment will only grow in line with its net investment return. Your preservation fund can only receive direct payments from another approved retirement fund. Choosing the most appropriate investment strategy for your investment horizon is therefore of the utmost importance.
Can I withdraw from my preservation fund?
Yes, you are permitted to make one full or partial withdrawal from your preservation fund before the age of 55, which is generally the retirement age for most preservation funds.
Can I split my retirement benefits between multiple preservation funds?
You are not able to split the proceeds from a single pension or provident fund across multiple preservation funds. However, you are permitted to invest the proceeds of different pension or provident funds across different preservation funds, although bear in mind that the tax-free portion on withdrawal will be calculated as a cumulative total across all your preservation funds.
Do I have to transfer my retirement benefits to a preservation fund?
No, you also have the option of transferring your retirement benefits tax-free to a retirement annuity. However, bear in mind that you cannot access funds housed in a retirement annuity (RA) before age 55. As in the case of a preservation fund, no tax is paid on the investment returns achieved in your RA and the proceeds of your RA do not fall into your deceased estate and therefore do not attract estate duty.
Can I transfer my preservation fund to another preservation fund?
Yes, you are permitted to transfer your preservation fund to another preservation without incurring tax. You are also permitted to transfer it to a retirement annuity or to your employer’s retirement fund without paying tax.
What happens when I retire from my preservation fund?
You are permitted to retire from a preservation fund from age 55 onwards. If your pension preservation fund balance exceeds R247 500 when you retire, you are permitted to take a one-third cash withdrawal which will be taxed accordingly. Thereafter, you are required to use the remaining two-thirds to purchase a life or living annuity in accordance with your needs. As it stands, legislation currently allows for 100% lump sum withdrawals from a provident preservation fund, although this legislation is scheduled to change with effect March 2021 whereafter the proceeds from provident preservation funds will be subject to annuitisation (excluding any vested interest in the provident fund prior to March 1 2020.
What happens if I choose not to preserve my retirement benefits?
If you decide to cash out your benefits, bear in mind that you will be taxed as per the withdrawal lump sum table. Further, keep in mind that by cashing out your money, you will effectively interrupt the compounding process and lose all future growth on your investment.
What happens if I emigrate?
If you financially emigrate from South Africa, you are permitted to make a full withdrawal of the funds in your preservation fund, regardless of whether you have made a previous withdrawal.
What happens to my preservation fund if I die?
When you die, the trustees of the fund are responsible for allocating your preservation funds among your financial dependants. While you may have nominated certain beneficiaries in respect of your preservation fund, it is the fund trustees who make the final decision. In making a determination, the trustees will consider all people who were financially dependent on you in any way prior to your death.
What should I consider before transferring to a preservation fund?
While preserving your retirement benefits is always the preferred option, these are uncertain times and many people may have no option but to withdraw their money in order to survive. Deciding what to do with your retirement benefits involves careful consideration, taking into account the tax implications, your short-, medium- and long-term needs, your investment horizon, and your chances of re-employment in the near future.
If you are concerned that you may be unemployed for a while or may need access to your capital before retirement, a preservation fund may be a better option than a RA as it allows you a once-off withdrawal before age 55. If you are confident that you will not need the capital before retirement, then a RA could be a suitable option, especially if you continue to make regular contributions towards the RA.
On the other hand, if you are in financial distress, you may want to consider withdrawing up to your tax-free limit and then investing the balance into a preservation fund. As always, it is advisable to seek the advice of an independent adviser before making a decision.