What is a Provident Fund?

One day, we all want to retire. We want to retire, put our feet up and enjoy the last few years or decades of our lives. We want to spend time with family friends and maybe even travel. To do this you need to save for retirement. However, the question many people are asking is where to save your retirement money?

Recently we covered retirement annuities, what they are and what their benefits are. This week we want to look at provident funds.

Provident Fund vs Retirement Annuity?

Provident funds are a type of Pension Fund offered by your employer. This is a workplace-based fund, and you cannot take out a provident fund on your own. On the 1st of March 2021, the laws were updated on how provident funds work. According to Old Mutual, you previously were able to take out the entire lump sum benefit at retirement. However, the laws have been changed.

Now at retirement, you are required to take out 1/3 of your provident fund as a lump sum. The remaining 2/3 must be used to buy a pension fund that provides a monthly income.

This setup is very similar to a retirement annuity, except a retirement annuity would be taken out by yourself and not through your employer.

How Does Tax work on Provident Funds?

Tax on provident funds is very similar to those on a retirement annuity. When you retire and take your 1/3 lump sum, the first R500 000 is tax free. After that, they are taxed on a sliding scale.

According to Liberty, your contributions to a provident fund are tax-deductible. This is up to a maximum of 27.5% of your income or R350 000 per year. This means you can reduce your taxable income while investing for your retirement.

What to do with Provident Fund When Resigning?

If you resign or are retrenched and leave the company you have a few options for your provident fund.

  1. You could move it to your new employer’s provident fund. This allows you to keep growing the money towards your retirement with no further tax implications.
  2. You can move your funds to a preservation fund until you retire. These funds aim to grow your money and will payout upon retirement. They are also tax-efficient vehicles.
  3. You can take out the money as cash. While this can seem like a good option, you must take into account that all of this money is taxed.

Retirement can be a tricky business and often speaking to an expert can help. Reach out to your financial advisor and find out which options suit your needs best.