Cashing in on your retirement lump sum: what you need to know

Question

I will be retiring soon and can take out one-third of my retirement savings as a lump sum. Should I do this?

Answer

When you retire, you are allowed to take onethird of your retirement savings as a cash lump sum. The question, however, is: do you take the full onethird or just part of it?

There is a special tax table that applies to this lump sum and the tax level increases with the size of the lump sum taken. The table on the right shows the tax rate for the various levels of the lump sum.

I provide retirement counselling to pension funds and when I help members make this decision, we look at their current tax rates. If any part of the lump sum will be taxed at a higher rate than their current marginal rate, I caution them to think twice about taking such a big lump sum.

I usually recommend that you take the first R500,000, as it is taxfree, and if you invest it cleverly, you can end up better off.

I strongly recommend that all pensioners have an emergency fund. Life happens, and you will need funds to pay for medical treatment, household repairs or new tyres for your car. If you do not have such a fund, then it makes sense to use your retirement lump sum for this purpose.

Now the mistake that many people make with their lump sum is that they leave it all in a bank account with a low interest rate. They argue that it is their retirement money, and they cannot take a chance with it.

What they do not appreciate is that this emergency fund will probably have to last for 25 years and needs to keep up with inflation over that period. I recommend that they consider using my three-pot approach and split up their lump sum according to the timeframe over which they may need the money. (See the table above.)

So, if you need new tyres for your car in 10 years’ time, that part of your emergency fund should have grown enough to keep up with the increased cost of tyres.