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Long-serving civil servants still qualify for big tax breaksLooks at recent amendments to the Income Tax Act
CIVIL servants used to be wrapped in a protective cocoon by the state and showered with perks such as tax exemptions and preferential treatment on home loans. But not any more. One by one their perks are being removed. The latest to go - one of the truly great advantages of being a civil servant in the past - was removed in last year's budget and came into effect earlier this year. Lump sums payable on retirement by a state pension fund after February 28 this year are no longer tax-free. Beric Croome, tax partner at Grant Thornton Kessel Feinstein, says the Income Tax Act was amended so that lump sums payable by public and private pension funds would be treated equally for tax purposes from March this year. To civil servants this means the portion of their lump sum payout which accrued before February 28 this year remains tax free, while the portion accrued from March 1 is taxable. Another change for civil servants is the application of the tax-free formula on retirement lump sums. This rule has always applied to lump-sum retirement payouts by private pension funds. The formula, which determines how much of your retirement lump sum payout from a fund is tax-free, works like this: the tax-free amount is the greater of R120 000 or R4 500 multiplied by years of service. The way the tax-free lump sum portion for retiring civil servants is now calculated is best illustrated by way of an example - set out in two steps, as it is quite complicated.
Step one Say Ann Jones, a member of the Government Employees Pension Fund (or any other public sector fund), is due to retire on March 1 2000. Jones has been with the pension fund for 40 years and her fund has informed her she is entitled to a lump sum of R400 000 on retirement. Her annual average salary over the past five years is R50 000. Jones is therefore entitled to the following tax-free lump sum for her 38 service years completed on February 1998: 38 (years of membership before March 1 1998) divided by 40 (total years of membership), multiplied by R400 000, equals R380 000 tax-free. Regarding her two years' service from March 1 1998 to retirement, the following applies: 2 (years of membership after March 1 1998) divided by 40, multiplied by R400 000, equals R20 000 (the taxable portion). So only R20 000 of Jones's actual lump-sum benefit would be taxable in terms of the new tax regulations for civil servants.
Step two However, this amount is now subject to the normal tax-free formula - R120 000 or R4 500 multiplied by years of service. Croome says pension fund members often assume that they automatically qualify for the R120 000 tax-free lump sum no matter how long they've been a member of the fund. But this is by no means the case, as the formula merely sets the maximum tax-free amount. In our example, the tax-free lump sum due to Jones would be calculated as follows: 40 (total years of recognised membership) divided by 10, multiplied by R50 000 (actual annual salary over five years limited to a maximum of R60 000), equals R200 000. But Croome explains that since this amount exceeds R180 000 (R4 500 multiplied by 40), the R180 000 would apply. Since Jones is entitled to R380 000 tax-free when she retires - as this money was accrued before 28 February this year, and because the R20 000 lump sum due for the two years after March 1 is less than the tax-exempt lump sum - she will get the entire R400 000 tax-free. Croome says this illustrates that state employees who have been members of their pension funds for many years and who are due to retire within a few years will not be affected in a big way by the tax law changes.
Another prime benefit afforded to civil servants is the favourable deduction regime for public funds, in which state employees can contribute as much as they like to pension and provident funds and deduct these amounts from tax. Members of private pension funds, on the other hand, can only deduct from tax their contributions not exceeding R1 750 or 7.5% of retirement funding income (whichever is greater). Croome says this will change from March 1 next year when the same limits will apply to civil servants. This makes it possible, however, for civil servants, especially those very close to retirement, to increase their level of contributions before March next year to boost their lump-sum payout.
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