How much should you take as a retirement lump sum?

In the recent National Budget, the tax-free lump sum that can be taken on retirement has been increased by 10%. On retirement or retrenchment, it now amounts to:

In the case of pension and retirement annuity funds, one-third of your retirement fund is available as a lump sum on retirement from the fund. For provident funds, up to 100% of the accumulated contributions until 28 February 2021 is available to be taken as a lump sum. (Lump sums available from provident fund contributions accumulated from 1 March 2021 are treated like pension funds.)

 If you want to take a lump sum on retirement, the question is: How much should the lump sum be, and in particular, how much more than the tax-free portion? Various factors will determine the outcome, including:

• What will your post-retirement marginal tax rate be?

(The marginal rate is the rate at which additional income is taxed.)

• Do you have any outstanding debt to be settled?
• Do you have other capital sources for an emergency fund or future asset replacement?

Considering your overall financial planning, you will take the tax-free portion, from which a tax-free income can be earned, versus a minimum income tax rate of 18% if you exceed the tax threshold. This means you will use at least 18% less capital to receive the same net amount. Whether you should take more, will depend on your marginal tax rate. If it is say 36%, it makes sense to also take at least the portions that are taxed at 18% and 27% respectively.

The golden rule is to pay off any debt when you retire. The motivation is that you are then guaranteed tax-free growth equal to the interest rate you pay. If you have some capital available, in most cases the answer is simple – pay off the debt. However, whether you should take a lump sum taxable at 36% while your marginal tax rate is only 18%, is not that simple. In this case, it would probably be better to let the loan agreement run its course.

As with many things in life, there is no ‘one-size-fits-all’ solution. I would suggest that you contact a licensed financial planner for an analysis of your individual circumstances and a recommendation.

Finally, just be mindful that lump sums taken from retirement funds are taxed cumulatively. The increased tax-free limit does not imply that you automatically qualify for an additional tax-free amount.

Email: jac@psg.co.za

This document contains general information only. It does not constitute financial, tax, legal or investment advice and the companies in the PSG Konsult Group do not guarantee its appropriateness or potential value. Since individual needs and risk profiles differ, we suggest that you consult your qualified financial adviser if necessary. PSG Wealth Financial Planning (Pty) Ltd is an authorised financial services provider (FSP 728).