This article will explore the tax consequences where a member of a retirement fund and his/her spouse gets divorced and the member spouse’s retirement benefits are to be divided between him-/herself and the non-member spouse.
Where the non-member spouse will receive a portion of the member spouse’s retirement fund in terms of the divorce court order, the type of fund must be determined as the interest of the member spouse and the non-member spouse in the retirement fund (the fund interest) is calculated differently depending on which type of fund the member spouse belongs to.
In the case of pension and provident funds, the amount of the fund interest of the member spouse is determined as the amount the member spouse would be entitled to if he/she resigned from the fund on the date of the divorce.
When a retirement annuity fund is involved, the amount of the fund interest of the member spouse is determined by the following formula:
- Total contributions to retirement annuity fund up to date of divorce
- Annual simple interest* on the amount of the total contributions up to the date of divorce
* at SARS’ prescribed interest rate on the date of divorce
The pro rata portion of the member’s fund interest due to the non-member spouse is usually calculated as a percentage, e.g. 30%, of the amount of the member spouse’s retirement fund interest.
When the non-member spouse receives their portion of the fund interest, the tax implications in terms of the Income Tax Act are activated. In terms of the Income Tax Act, the member spouse is liable for Income Tax on the gross portion of the fund interest allocated to the non-member spouse as if it has been received by the member spouse.
Furthermore, the Income Tax Act determines that the non-member’s portion of the fund interest will be taxable in the member spouse’s hands, even if it has just accrued to the non-member spouse – the amount does not actually have to be received by the non-member spouse before the tax implications realise. The member spouse will be liable for Income Tax on the non-member spouse’s portion at the earliest of accrual to or receipt by the non-member spouse of their pro-rata portion of the fund interest.
The member spouse has an automatic right in terms of the Income Tax Act to recover the Income Tax paid to SARS from the non-member spouse. The net portion that the non-member spouse will receive, will thus be calculated as follows:
Gross portion of fund interest allocated to non-member spouse
Income Tax due on gross portion of fund interest allocated to non-member spouse
The taxability of the non-member’s portion holds serious consequences for both spouses. There are cash flow implications for the member spouse as he/she might have to carry the tax expense until it is recovered from the non-member spouse. A major financial consequence for the non-member spouse is that the net amount of the portion of the fund interest they actually receive after the member spouse recovered the tax from them, could be significantly lower than the gross amount of the pension interest originally allocated to the non-member.
It is crucial for both spouses to obtain professional advice regarding the possible tax implications of the divorce settlement before finalising the settlement agreement to prevent serious negative financial consequences for both parties to the divorce.
This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)
Accessed on 29 September 2015