The limits of flexibility regarding retirement benefit elections in a pension or provident fund
By, Anita Roodman Senior Manager: Legal and Technical
Pension and provident funds often face uncertainty as to whether members can choose the type of benefit they qualify for when leaving an employer. This raises two key questions: Can a member retiring from employment elect to receive a resignation benefit? Conversely, can a member resigning from employment opt for a retirement benefit? These benefit types differ significantly in terms of tax implications and payment structures, making it essential for funds to understand which options are permissible.
Can a member retiring from employment elect to receive a resignation benefit?
Members of pension funds often request a withdrawal (resignation) benefit upon retiring from employment, even though they have reached the age that entitles them to a retirement benefit in terms of the fund rules. This is typically done to access the full lump sum from their vested component and avoid the requirement to use two-thirds of the benefit to provide them with an annuity.
The definition of “pension fund” in the Income Tax Act requires a fund to provide annuities to members on retirement from employment. It provides that the Commissioner shall not approve a pension fund in respect of any year of assessment unless he is, in respect of that year of assessment, satisfied:
“that the fund is a permanent fund bona fide established for the purpose of providing annuities for employees on retirement date or for the dependants or nominees of deceased members, or mainly for the said purpose…”
General Note 4/95, issued by the then Commissioner for Inland Revenue, emphasises the above requirement and determines that if the rules of a pension fund, directly or indirectly, makes provision for a withdrawal benefit to be paid to a member at retirement or nearing retirement where the member is actually retiring from service, the fund will be deemed not to have been established for the bona fide purpose of providing annuities for members on retirement from employment. As a result, the fund’s approval for income tax purposes will be withdrawn.
So General Note 4/95 confirms that a pension fund must not allow its members to opt for a withdrawal benefit just before they reach normal retirement age in order to access a lump sum benefit that is not accessible via a retirement benefit.
Although some may argue that General Note 4/95 lacks legal force, the Income Tax Act sufficiently expresses, in its definition of a pension fund, the requirements necessary to maintain its tax-approved status. One such requirement is that a pension fund cannot allow a member to take a withdrawal benefit when a retirement benefit is in fact payable. This practice is precisely the mischief that General Note 4/95 seeks to prevent, and which is in any event prohibited by the Income Tax Act.
It is thus imperative for funds to determine the reason for termination from service from the employer, because the type of exit event determines the benefit the member will receive from the fund. For example, an employee cannot retire from the service of the employer to receive a certain employer-subsidised benefit and then withdraw from a fund to receive a different benefit. The exit event at the employer will be the same exit event that determines the member’s benefit.
There may be circumstances where a member’s resignation shortly before reaching their normal retirement age is a bona fide resignation to take up alternative employment, and not an attempt to access a lump sum benefit. In that case a withdrawal benefit will be the correct benefit to be paid.
However, to blindly allow such withdrawals puts the fund at risk of losing its tax approval, so the fund should satisfy itself that adequate checks and balances are in place to detect and prevent the practice of paying withdrawal benefits where in fact the member is retiring from service. The necessary questions need to be asked by the employer to establish whether the member’s resignation from employment is in fact a bona fide resignation. The employer should also be aware of the risk involved if they manipulate the termination of employment forms to enable members to receive their withdrawal benefit.
The same principle applies to provident funds, although the tendency is lower because a larger portion of provident fund members’ benefits – the part that accrued before 1 March 2021 – may in any event be taken in the form of a lump sum upon retirement.
The introduction of the two-pot retirement system will gradually resolve this risk to pension and provident funds, as vested components are phased out. In the meantime, however, funds must remain vigilant to ensure that members do not access a lump sum from their vested component when the law requires that at least a prescribed portion of the benefit be used to provide an annuity.
Can a member resigning from employment elect to receive a retirement benefit?
Effective 1 March 2019, the “default regulations” introduced by the Pension Funds Act requires a member who leaves the service of an employer participating in a pension or provident fund and who ceases active contributions, to automatically become a paid-up member of the fund. This status remains until the member provides written instructions to either withdraw the benefit or transfer it to another fund. The purpose of this provision is to discourage members from taking their withdrawal benefits in cash, which could significantly reduce their long-term retirement savings.
In addition, for tax purposes, the accrual date of a member’s withdrawal benefit is the date on which, after leaving employment, the member elects to receive or transfer that benefit. Pension and provident fund rules typically allow paid-up members to keep their benefit in the fund until they reach an age at which they can receive it as a retirement benefit. It is essential that this provision be clearly stipulated in the rules, as the employment relationship between the paid-up member and their former employer no longer exists.
Paid-up members who left the service of the employer before retirement, may therefore always have the option to access their benefits either as a withdrawal benefit or a retirement benefit when they reach the stipulated age as described in the rules of the fund.
It is worth noting that the Income Tax Act does not prescribe a minimum age at which members of a pension or provident fund will become eligible for a retirement benefit. Previously, paragraph 4(3) of the Second Schedule provided that if a member of a provident fund retired before age 55 for reasons other than ill health, the benefit would be taxed as a withdrawal rather than a retirement benefit. This provision was repealed with effect from 1 March 2023 to align the treatment of pension and provident funds, eliminating the need to differentiate between them for retirement purposes. This change makes sense against the backdrop of annuitisation and the two-pot system, where members will in any event have restricted access to their benefits upon withdrawal.
Although the Income Tax Act does not impose a minimum age for qualifying for a retirement benefit, most provident fund rules still require members to be at least 55 years old. This provision aims to prevent misuse of the tax dispensation. Historically, provident funds allowed members to take their entire retirement benefit as a lump sum, and the bulk of many members’ benefits in a provident fund is still this lump sum portion – i.e. the part that accrued before 1 March 2021. Due to the tax treatment of lump sums at retirement being generally more favourable, the Income Tax Act stipulated that benefits paid before age 55 would be taxed as a withdrawal rather than a retirement benefit, and provident funds contained this provision in their rules.
To prescribe a minimum retirement age in the rules will become unnecessary over time, as members’ vested components will shrink/be phased out.
Recommended considerations for pension and provident funds:
- Review fund rules to ensure that a withdrawal benefit is not payable when a member is actually retiring from service.
- Implement robust checks and controls to detect and prevent the payment of withdrawal benefits to members who are retiring from employment.
- Educate employers on their responsibilities regarding members exiting employment and the completion of exit forms, especially in an umbrella fund where the fund relies on the information received from the employer.
- Clearly define in the rules when a paid-up benefit will become payable and in what form.
- Specify in the rules the age at which or conditions under which a paid-up member qualifies for a retirement benefit.
- Align rules, processes and claim forms so that employer consent or confirmation is not required for paid-up members electing to receive their benefit as a retirement benefit.
25 February 2026