After saving towards your retirement for a couple months, you may feel an itch to withdraw the funds to cover some unexpected expenses, or pay for your next vacation.
However, what are the consequences of doing this? We got in touch with two financial experts to find out what this means for your long-term retirement goals.
Tip: Start saving for retirement now by filling out the form on this page.
What are the short-term results?
Jason Apple, certified financial planner at Chartered Wealth Solutions, believes that very careful consideration must be made before withdrawing from a retirement annuity (RA) or any other retirement fund. He suggests you always seek financial advice before making this decision.
He explains that the South African Revenue Service (SARS) allows you a lifetime tax-free withdrawal from retirement funds of R25,000 before retirement and R500,000 after retirement.
“You can withdraw from an RA early if the RA value falls under R7,000 or you emigrate to a different country. However, the tax-free withdrawal allowance of R25,000 reduces every time you make a withdrawal. Once this withdrawal allowance is used up, the tax payable on future withdrawals can be as high as 36%,” says Apple.
“SARS do tax withdrawals from retirement funds quite aggressively in order to discourage people from accessing their retirement savings early,” he adds.
Tayla Snowball, financial planner and healthcare consultant at BDO, uses an example to explain the short-term consequences of withdrawing your retirement earlier.
“If you have R5,000 in your RA and you decide to withdraw it, then the whole R5,000 will be free of tax, as it is within the R25,000,” says Snowball.
“However, this means you’re now only left with an amount of R20,000 tax free for any future withdrawals from a retirement fund. Any amount which exceeds the portion you still had tax free, will now be taxed,” she explains.
What’s the long-term impact?
Apple believes there’s quite a big impact in the long run because SARS applies the principle of aggregating all past lump sums you take from retirement funds with the future withdrawals you make.
“This means that when you retire, SARS will add every lump you have ever withdrawn, together with the lump sum you take when you retire, and calculate the tax on the total lump sums. They then deduct any amount of tax you had paid in past, so you don’t pay double tax but they ensure that you don’t get the tax benefit of the withdrawal again when you retire,” says Apple.
“Withdrawing R7000 out of your RA’s chips away at the R500,000 retirement lump sum. Most people forget this and are in for a nasty surprise when they retire and try to take the full R500,000 tax-free lump sum,” he adds.
“Another important consideration is that no income tax is payable on investment returns within a Retirement Fund (including RA’s). If you keep withdrawing your money out of a RA you also erode the future tax-free returns you can make on those funds and this can compound to a considerable amount over time,” says Apple.
Snowball expands on her previous example to illustrate the long-term impact of taxes on early retirement withdrawal.
“Let’s say you now resign from your employer and you have R40,000 in your Provident Fund. Remember you’ve already withdrawn R5,000 of the R25,000 tax-free portion, so you only have R20,000 of the tax-free portion left,” says Snowball.
“The amount of tax you would pay on this R40,000 withdrawal is R3,600, or 9%. So, after tax you get to keep R36,400. Had you not taken that R5,000 from your RA in the earlier example, the tax you would have paid on this example would be R2,700 or 6.75% - that’s a R 900 difference,” she explains.
“This might not seem like a lot of money, but the impact is continual. Now the next time you withdraw you’ll have zero tax-free relief, and you will be taxed on the whole amount you withdraw going forward,” she adds.
How many times can you withdraw from an RA?
According to Apple, you must be aware that withdrawing several times from an RA could be viewed as suspicious from a FICA perspective and doing this multiple times a year or with multiple providers could result in a suspicious transaction report being lodged.
“You will need to have all your proof handy to evidence that the funds are from a legitimate source when making any investment. Every time you cash in your RA and take funds out you deplete the remaining tax-free withdrawal allowance (R25,000) and tax-free retirement lump sum allowance (R500,000),” says Apple.
Snowball points out that investors are permitted to take out as many retirement annuities as they like. However, the consequences of doing so should be considered properly.
Apply for a retirement annuity by going to this page and filling out the form.