Understanding Retirement Savings: Annuity vs Lump Sum Withdrawal and Tax Implications.

2024-03-18 07:54:00

We save for years for retirement, whether we are employed or self-employed. The purpose of the savings we have accumulated is, as we know, to maintain the standard of living even after we retire. That is, the savings we have accumulated should replace the income from work we received before our retirement. It is also called “the turnover ratio”, which is the result of dividing the pension after retirement and the salary from work during the career before retirement.

However, is it really the only way to realize the pension savings by way of an annuity, or is it also possible to withdraw the savings as a lump sum? Indeed, from the pension plans there are cases and conditions for a one-time withdrawal as well. Therefore, when you reach the age of realizing the funds, you should examine the options between drawing an annuity and a one-time withdrawal and choose a way that suits the retiree’s needs along with reducing the tax.

We will try to understand the difference between a pension withdrawal and a lump sum – How is the allowance calculated in the pension plans? As a rule, the savings saved in the pension plan over the years are divided by a figure called the “conversion factor”. This figure is calculated based on the expected life expectancy and based on the interest that the insurance company/pension fund assumes will be obtained on the funds. The amount of savings divided by the conversion factor is the monthly allowance that the saver will receive for the rest of his life. You can choose between different pension tracks, the difference between which is how much we would like to guarantee to the spouse and/or the beneficiaries. The lower the conversion factor, the higher the annuity paid.

There are old plans, which are based on mortality tables from the 1950s as well as a guaranteed return – therefore the conversion factor in them is low and the pension you receive is higher. In the old pension funds, the allowance is calculated on a different basis, and the calculation varies between the types of old funds.

From this it can be understood that the body that pays us the pension assumes the life expectancy risk. The longer we live, the greater the risk of the paying body. When we come to withdraw a one-time amount, which should be used by us to maintain our financial security and to supplement our income, we need to manage it so that it will be enough for us for the rest of our lives, or alternatively, it will be enough for us until the savings are exhausted.

And what about the tax?

The tax that is paid on the pension is the same as the tax that is paid on the income from work – that is, according to the tax brackets. When you reach retirement age, there is no deduction from the pension for national insurance and health tax, and you can take advantage of an exemption from the pension as part of the “fixation of rights” process. In addition, from the age of 60 you can benefit from a tax benefit on the pension for deposits on which we have already paid “recognized pension” tax. That is, tax benefits apply to the pension.

The tax on a one-time withdrawal of the pension savings varies greatly between the types of funds we have saved, and there are various tax shelters that can be taken advantage of. Some of the funds can be realized by capitalizing an allowance, and in this way the possibilities to minimize the tax are greater.

Below are some examples of funds that can be withdrawn as a tax-free lump sum from the pension plans:

• compensation money – At the end of the work, you can take advantage of an exemption for each year of seniority, which currently stands at NIS 13,750 per year. Utilizing the exemption for compensation reduces the exemption given at retirement age on the pension. Withdrawing tax-free compensation from the plans reduces savings and expected retirement.

If we take for example, an employee whose monthly salary is NIS 20,000, with 10 years of service, who has accumulated NIS 200,000 in compensation in his pension plans. At the end of his work, the same retiree will be able to take advantage of an exemption for compensation in the amount of NIS 137,500 (the calculation is NIS 13,750 multiplied by the number of years of seniority). In such a case, the balance of NIS 62,500 is taxable, and it can be left to draw an annuity in retirement (“annuity sequence”).

• Reward money in an annuity plan accumulated until January 2000 – Funds that are exempt from tax and capital gains tax from the age of 60.
• Capital reward funds accumulated until January 2008 – funds exempt from tax and capital gains tax already from the age of 60.
• Other pension funds that are taxable and we would like to withdraw them as a lump sum – You can request to capitalize them and use tax shelters available at retirement age to minimize the tax. Pension capitalization is possible when we reach retirement age and we receive a “minimum pension”, which currently amounts to about NIS 5,000. Capitalization means that you can receive a lump sum in advance from the funds intended for retirement at the expense of reducing the allowance. The use of capitalization expands the possibilities of using the tax shelters and tax benefits to exempt from tax the withdrawal of lump sums.

So, we understand that it is also possible to withdraw lump sums from the pension plans, but is it correct to do so?

When we come to plan our retirement, the question of how much of the savings to realize as a pension and how much as a lump sum or annuity capitalization is one of the milestones in retirement planning. The answer will be through an understanding of the level of monthly expenses of the family unit, the existing monthly income from savings and other assets, the total savings and assets available to the retiree, the total savings and expected future expenses, the health status of the retiree and his family members, as well as the personal preferences of the retiree and the level of risk he is willing to take, In addition to the types of pension plans he has.
From the holistic picture, it is possible to create tax optimization, which will combine drawing an annuity with a one-time amount suitable for the needs of the retiree and his family.

The author is the VP of Retirement and Pension Planning of the Kelly Group. The above should not be considered a recommendation or advice and it is not a substitute for personal pension advice that takes into account the needs and data of each person.