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What happens to your pension if you resign?

Reader’s questions answered.

CAPE TOWN – In this advice column Geraldine Macpherson from Liberty answers a question from a retired reader who wants to understand the difference in benefits between resigning or retiring from the Government Employee’s Pension Fund (GEPF).

Q: I am employed in the Government sector and am a member of the GEPF. I have the following questions:

Does the R500 000 non-taxable portion of the lump sum from a pension apply to GEPF members who resign?

What is the maximum taxation on the remainder of the lump sum pay-out?

Am I correct to say that if I resign then I can take more than one third of my retirement capital as a lump sum?

I would also appreciate a bit of background on the pros and cons of resigning rather than waiting for retirement, and what mistakes one needs to be conscious of avoiding.

The GEPF is governed by the Government Employees Pension Law, Act 21 of 1996. This makes it different to private sector funds, which are governed and regulated through the Pension Funds Act and other relevant legislation. This can result in some important differences when it comes to accessing benefits.

The taxation of benefits from public funds like the GEPF and private sector funds were aligned in March 1998. Before this period all benefits from the public sector funds were tax free.

However, after March 1 1998, only the benefits that had vested prior to March 1 1998 pay out tax free and the balance are subject to either the retirement tax table or the withdrawal tax table, depending on the reason for the benefit being paid.

With that as the background, let us look at your specific questions. With regards to whether the first R500 000 of a lump sum taken on resignation from the GEPF will be tax free, the answer is no. A resignation or dismissal will result in a “withdrawal” benefit being paid, which is distinct from what happens at retirement. In these circumstances, only the first R25 000 of the taxable lump sum is tax free, and this only counts once. There are no tax-free amounts for subsequent withdrawals.

It is very important to think carefully about whether to withdraw from a fund or to preserve your savings. Other than the fact that withdrawals generally result in the member having insufficient capital at retirement to sustain a reasonable standard of living, a further impact of a withdrawal is that it reduces the tax-free amount available when you retire.

As a very simple example: If you withdraw R200 000 from the fund you will get R25 000 tax free and you will pay tax at 18% on the balance. That means that you have basically forfeited R175 000 of tax-free money that you could have accessed when you retire.

The idea is really to dissuade members of funds from taking withdrawals through a sort of tax “penalty”. The problem is that many members of funds are not aware of this “penalty” and so make decisions and then later have to suffer the consequences.

In terms of the maximum tax payable on a lump sum, all taxable withdrawal and retirement lump sum benefits are taxed at fixed rates in terms of the withdrawal and retirement tables. The top bracket is 36%.

If you resign from your job, you may take a full, taxable, withdrawal from the GEPF. Your other option is to preserve your benefit, by transferring it into an approved pension preservation fund or a retirement annuity fund. There is a benefit calculator on the GEPF website which can be very useful to members to see the impact of a withdrawal versus preserving the benefits.

What is specific to the GEPF in this case is that if a member does elect to preserve, they are still entitled to withdraw one third as a lump sum from the preservation fund. This is not the case with private sector fund benefits. If you do this, then the one third you would ordinarily be allowed at retirement will be reduced by the amount taken as a withdrawal at this stage.

Despite this, withdrawing instead of preserving can be a costly exercise. Not only may the member pay up to 36% tax, they will forfeit tax-free benefits at retirement. They will also lose out on the tax-free growth on the investment that is enjoyed in a retirement fund.

One other thing to be aware of is that employees who resign just to get their hands on the benefits expose their money to the risk that their creditors may now access those funds. While in a retirement fund they are fully protected from creditors and insolvency.

Remember that unemployment is a big problem in South Africa. There is no obligation on the employer to re-employ you if you resign to access your benefits. Even if they do take you back, they may agree to re-employ you on less favourable conditions. The emerging practice of employees resigning to access their fund benefits is an extremely risky one and is not advisable.

Geraldine Macpherson is a senior legal adviser with Liberty.

If you have any questions you would like answered by financial planning experts, please send them to editor@moneyweb.co.za.

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