We all may have heard by now that the South African Revenue Service (SARS) penalises two-pot withdrawals. In fact, they have been very vocal about it themselves, and have even budgeted for the income they will receive in this way.
The reason for the penalty is that government encourages us to save for our retirement by giving us tax rebates when we do. In a way they’re “taking back” the rebate when we withdraw from the savings. The size of the rebate, and penalty, equal the tax rate you normally pay on your salary or income at the time of the contribution or withdrawal. We refer to this again below.
At the moment, your financial services company asks for a tax directive as soon as you request a two-pot withdrawal. SARS then tells them what percentage of the amount to pay over to them, and on top of that to take off any money you owe SARS.
But there is another tax surprise regarding two-pot that investors may be unaware of.
This has to do with your income bracket. The tax rate we normally pay, the so-called marginal rate, is based on an income bracket or range. If your current income is close to the top level of the bracket, your investment income from your two-pot withdrawal can push you over that level into a higher tax bracket. You can also be pushed into a higher bracket if you get a salary increase at any time during the tax year. Or another windfall. Sometimes, it will be the combination of a two-pot withdrawal plus your increase that can push you to a higher bracket.
When it’s time for your yearly tax assessment towards July, SARS will look at your total yearly income, determine your tax bracket, and claim tax from you based on the full picture. Best is to realise that you may have to pay more tax on the amount in the higher bracket based on your “sins” for withdrawing from two-pot and receiving a higher income. The concern regarding this is that if you didn’t pay the higher tax when the withdrawal was made, you will have to repay this when you submit your annual tax assessment. If you cannot afford it at the time and have to make another two-pot withdrawal to pay SARS, it perpetuates that you keep paying the emperor more than what you had anticipated.
At Investo, we are also seeing the trend that clients fill in “nil” when we ask them for their yearly taxable income when they do their two-pot withdrawal. The same principle may bite them when SARS does their yearly assessment. If you earn a taxable income, SARS will demand its pound of flesh, comes assessment time. You are only postponing the pain or making it worse.
The below example is a reminder of how much tax you will pay on a two-pot withdrawal:
Let’s say Peter earns a taxable yearly income of R600 000 or R50 000 per month – this means he pays a marginal tax rate of 36%. He has R150 000 saved up in his retirement annuity and wants to withdraw R15 000. SARS will indicate that he must pay R5 400 tax. If the withdrawal fee is R200, he will receive only R9 400 in his pocket.
That’s why financial advisers will say it’s not worth it to withdraw. And, if you are in trouble and absolutely need to use your retirement savings, maybe the painful payment to SARS will encourage you to start building an emergency kitty. We know it’s tough out there, but debt, or borrowing from your future self, is not worth it. Drawing up a long-term financial plan, and sticking to it, beats wasting hard-earned money on paying tax that could have been avoided.