It’s not uncommon to change jobs every few years and at the same time decide to cash out your provident fund. It seems like a great way to access some quick cash, but is it really worth it?
Tax discussions can be so boring, but they are important. For example, cashing in your provident fund seems like a great way to get that much-needed money to pay off a debt, take a quick holiday or even to invest. So why wouldn’t you? After all, many people have trust issues when it comes to their employer’s choice of fund administrator, and would much rather have more control over their investments. This is understandable, but it’s certainly best to chat to your financial advisor before jumping ship.
Calculating the tax
It’s pretty simple to calculate the tax you’ll pay if you decide to withdraw some or all of your money, using SARS’s Retirement Lump Sum Benefit tax table, which currently looks like this:
- The first R25,000 is tax-free.
- For amounts between R25,001 and R660,000 you will pay 18% of taxable income exceeding R25,000.
- For amounts between R660,001 and R990,000 you will pay R114,300 + 27% of taxable income exceeding R660,000.
- For withdrawals of more than R990,000 you will pay R203,400 + 36% of taxable income exceeding R990,000.
Say, for example, Thabo withdraws R300,000 from his provident fund. The tax due would be 18% of R275,000, which is R49,500 (effectively 16.5% of the total amount).
As another example, Melissa withdraws R1,250,000 and pays R297,000, which is an effective rate of close to 24%.
Clearly, the larger the withdrawal amount, the larger the effective tax rate is and the more carefully you should consider withdrawing the funds
Jumping between jobs
The younger you are, the more likely it is you’ll be changing jobs often, and it’s not uncommon for a 20-something-year-old to switch jobs 10 or more times in their career. And it’s not just limited to changing companies – many will have a complete change of career and essentially ‘reinvent’ themselves.
And, for most people, when faced with the option of a cash lump sum now versus preserving your fund for the future, the here-andnow usually wins. It’s hard to see the future benefit when you’ve got urgent commitments and responsibilities in the present.
I’ve tried to keep the following example as simple as possible. Lerato is 25 years old and contributes R5,000 a month towards her retirement. We’ll assume a 5% increase in contribution every year, and we’ll put in a small growth rate of 6% per annum on the investment.
This table shows how tax on withdrawal erodes Lerato’s investment, as she would either need to invest at a better growth rate than she currently has (and possibly with reduced fees) or she would need to invest for longer. This becomes far more evident when making withdrawals often throughout your career, but it’s unfortunately hard to depict as there are so many variables and options.
Tax implications and considerations
The truth of the matter is that one can never get away from paying taxes, and whether you bite the bullet now to free up your investments or wait until retirement, you’ll be paying tax somewhere. Preserving your funds, either by transferring them to your new employer’s provident fund or to a preservation fund, will potentially reduce your overall tax liability. It also prevents you from wasting it on tempting, but not financially astute lifestyle choices. Exiting early (and often) with low effective tax rates could be quite compelling if you consider that you might have otherwise bought an annuity with this money and been subject to marginal income tax rates on this money later in life. Then again, chances are your income would be lower, and you might likely not suffer income tax at these sorts of effective rates in any event. Another way to look at exiting at these lower tax levels is that it could be a great way to access after-tax money that can be invested for the long term, giving rise to capital gains, which are taxed at much lower rates than an annuity.
Things change though, when you consider withdrawal amounts in the millions, as the effective tax rate can jump as high as 33%. Again, this allows you to prevent being subject to paying marginal rates on an annuity when you reach retirement on this money, but it does mean crystalising a material tax burden now. The benefits of tax-deferred investing for the long term should then definitely be considered.
What’s the money for?
All these examples simply illustrate the tax implications of withdrawing from a provident fund or provident preservation fund. They don’t deal with whether you should or shouldn’t be withdrawing in the first place.
If you’re planning on investing the full amount then you’re probably headed in the right direction. If, however, the money is simply to pay off debt, improve your lifestyle, go on holiday or renovate the home, then you should really consider the future impact.
If you’re going to withdraw cash from your provident fund when you leave your job, it stings less if the balance of that account isn’t too large. The bigger the balance gets, the more tax you’ll pay. If you think there’s a better investment opportunity for the money (and it had better be pretty good), then seek sound financial advice and put the money to work.
The effects of compounding growth are often forgotten but the reality is that it is very challenging to ‘catch up’ on your investments.