By Ryno Crous
Given the current state of the economy in South-Africa and the world at large, both employees and employers have had to face some harsh realities associated with the proverbial “new normal”. One of these realities, that has unfortunately become a typical occurrence since the lockdown commenced, is retrenchment.
It is critical for employees to understand the options available to them should they find themselves receiving a retrenchment letter. Having knowledge of both the tax implications associated with each option available, as well as the long-term effect thereof on their retirement savings, will greatly assist in ensuring that prudent decisions are made during this challenging time.
Tax Implications: Accessing your Pension/Provident Fund
Fortunately, retrenchment benefits (proceeds from provident/pension funds) receive favourable tax treatment. These benefits are taxed in the same manner as retirement and death benefits in that the first R 500 000.00 of the severance benefit is tax-free and any amount over this limit will be taxed according to a sliding scale. It should be noted that the tax-free amount of R 500 000.00 is available to each individual over the course of their lifetime, and is proportionately reduced with every cash withdrawal received from retirement structures (i.e. pension/provident funds, retirement annuities and preservation funds). If a retrenched employee has ever received cash from retirement funds in excess of the tax-free portion, any subsequent cash withdrawals will be fully taxable.
Conversely, any portion of a retrenched employee’s retirement benefits not paid out in cash, but rather preserved in their employer’s retirement fund or with another approved provider, will not be subject to tax.
Tax Implications: Severance Pay, Gratuity and Miscellaneous Remuneration
- Severance pay is governed by the Basic Conditions of Employment Act, which states that you must be paid at least one week’s remuneration for every completed year of service, in the event of a formal retrenchment exercise.
- Gratuities are negotiable amounts that fall outside of the scope of your employment contract, and if paid at all, are usually based on years of service and multiples of earnings at retrenchment.
- Severance Pay and Gratuities receive the same tax treatment applicable to retirement funds. An employee may not preserve severance and gratuity payments as these amounts are paid out in cash, consequently becoming taxable (depending on how much of your tax-free portion you have not yet utilized).
- Notice pay, leave pay and other amounts stipulated in your employment contract form part of your remuneration and is taxed according to your marginal rate as income.
Tax Implications: Preservation
As mentioned, employees have the option to not access their retirement benefits at all when retrenched, but rather to preserve their capital in a preservation fund or exercise their option of in-fund preservation (preservation of capital using the employer-provided scheme rather than transferring to another approved retirement fund). Although this sounds like an ideal scenario, this option may not be suited to everyone’s needs.
When a retrenchment benefit is preserved, it is no longer classified as such, and the favourable tax treatment is forfeited. Individuals are entitled to make one full or partial withdrawal from a preservation fund prior to retirement, but this will be treated as a normal withdrawal and therefore taxable according to the applicable SARS tables i.e. only the first R 25 000.00 is tax-free and the remainder is taxed in accordance with the said table.
For instance, assume that an employee has been retrenchment but does not have an immediate need to use his retirement capital to fund living expenses during the period of unemployment, so he preserves his savings in a preservation fund. Some time passes and he has yet to find new employment, worse yet, he can no longer get by without an income and needs to access his preserved capital. Whatever amount he decides to withdraw exceeding R 25 000.00 will be fully taxable, as opposed to the greater tax benefit he could have utilised prior to preservation.
The possibility of retrenchment is unlikely to go away soon, and it is now more important than ever to familiarise yourself with the process involved and the tax implications. Speak to your qualified financial advisor to receive the best advice in terms the options available to you.