With so many companies retrenching their employees, I have had a number of opportunities to advise people who are getting retrenched. I am also picking a disturbing trend where some people are volunteering themselves for retrenchment as they see the severance package and their pension or provident fund as a way to “fast” money. Read more…
Many are therefore literally giving away hundreds of thousands of Rands to the tax man as they prefer to cash all of their money and buy cars, pay off debts, go on holiday, etc.. I am sharing this story from Sam [not his real name] with the hope that we will all learn from Sam’s story.
Sam was retrenched by a bank in 2009. Because of his good qualifications and work experience, he was optimistic that he would find a job within a year or so. Like some of the people who get retrenched, he wouldn’t preserve his pension. He actually cashed it all in and after tax, had just over R1,1 million in his account – this was both the severance package and pension. He thought his money would never run out. Amongst other things, he bought himself a new car cash and that cost him R350 000. He still had about R700 000 after buying the car. His list of “needs” never ended. Then it was a holiday with his girlfriend, a loan to this relative, etc… As the balance grew smaller, he kept thinking the job offer was coming soon. To cut the long story short, just over a year after retrenchment, he found himself penniless and still without a job. He was surprised at how quickly R1million can disappear when you don’t have a job and you have all the time to spend it. When the job still didn’t come, he eventually had to sell his car. Think very carefully about why you want to offer yourself for voluntary retrenchment as it might take you a very long time to get another job. The severance package and the chance of having your hands on your pension / provident fund might seem very attractive but you may just be setting yourself up for poverty in old age. Sam will, in all likelihood, never be able to catch up and have R1million to invest for old age. He has lost any interest he would have earned on his pension in the last 6 years. He is now in his mid- 40s and at this stage of his life, he is yet to put away decent money for old age. He eventually got a job 2 years after retrenchment but it was after he had lost everything. He had to take the job even though the salary on the new job was lower than what he used to get at the bank.
What could Sam have done to handle his retrenchment better?
- Severance package
The severance package is taxed and then paid into your account. Sam should have taken his severance package and used it to pay off his debts and saved the rest in a money market account because he didn’t know how soon he would find another job. I prefer a money market account to an ordinary cheque or savings account because he would at least earn a little bit more interest in the money market account and he would “hide” his money from himself. Imagine seeing a balance of over R400 000 when you withdraw money, you are likely to spend recklessly! He could then transfer just the amount he needs to live on each month from the money market account to his cheque / savings account. If his monthly expenses were R15 000, his package could have lasted him for at least 2 years i.e. R400 000 /15 =26.6 months
By cashing his pension, Sam gave away an estimated R292 000 to SARS in taxes. He could have transferred his pension tax free to a pension preservation fund. He was in his late 30s when he got retrenched. He would still have 1 withdrawal from the preservation fund at any time before the age of 55. The single withdrawal could be a partial or a full withdrawal. If he was still out of a job 26 months after retrenchment, then he could withdraw further funds from his preservation fund. His pension before tax was just under R1 million but it would have grown in the 26 months. Sam got a job 2 years after he was retrenched so he would never have needed to withdraw his pension.
When he got a job
Sam would still have his R1million plus interests in his pension preservation fund. He would still have a better chance of a financially secure retirement. He could exercise his 1 withdrawal anytime between now and age 55. I never advocate withdrawing funds for life style assets but if he ever encountered a financial crisis, his preservation fund would always be there to cushion him. He could withdraw R500 000 tax free from the preservation, should a need arise.
I now answer some of the most common questions I encounter in the market. A big thank you to Nikki Gajoo of Old Mutual Private Wealth for offering further clarity. Nikki’s responses are in green.
- The R500 000 is tax free only if it is COMPULSORY retrenchment rather than VOLUNTARY retrenchment – Correct. So be sure that you don’t offer yourself up for retrenchment as many people falsely believe that they will get the tax break even if it is voluntary retrenchment.
- If it is voluntary retrenchment then the retrenchee only get R25 000 tax free. For voluntary retrenchment, the Income Tax Act 58 of 1962 provides limited scope of tax relief in respect of severance payments. Accordingly, provided that all the provisions of section 10(1)(x) of the ITA are complied with, the first R25,000.00 of the severance package would be tax free. The balance of funds would be taxed at the individual’s normal tax tables.
In closing, I wish to urge every person who is getting retrenched to seek the assistance of a financial advisor. You don’t want to give money away, run out of money and end up poorer in old age. You can contact me on email@example.com for guidance or call us on 011 781 3351.
Tax is however just a small part of what you need to consider when you get retrenched. Other considerations are your budget, your home loan – if applicable, your car loan – if applicable, retrenchment protectors and premium waivers, your life cover, etc…