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Pension Interest & its Tax Liability in the Accrual Calculation

27 May 2019. As an actuary going through a divorce, I was surprised when I came to the realisation that many divorce accrual calculations ignore the tax liability on pension interests. It can be a complicated calculations, so where it is allowed for lawyers are only usually competent enough to estimate the tax liability as if it were calculated on a lump sum withdrawal basis. So, because it is difficult to estimate, the tax liability is usually either completely ignored in the accrual calculation in which case it'll usually it'll be the party with the largest pension interest who is losing out, or is incorrectly estimated. This is no small thing as, along with the house, the pension interest is often the largest asset in a divorce accrual calculation.

This article is the end result of many hours of personal research, including learnings from hours of expensive consulting sessions with industry experts. I'm publishing the article to hopefully save others the time and expense of doing the same.

This article is obviously only of relevance to those married with an Antenuptial Contract with accrual, in South Africa. You can identify this, as your antenuptial contract will have an introduction as in the image below:

Front page headline of an antenuptial contract in South Africa

And the ANC includes personal details (I've left out) and then something like the following:

Wording in an antenuptial contract referring to the Matrimonial Property Act

After this the commencement values and exclusions are listed. You may not think about it much when you're young, in love, and on your first marriage (!), but these words can have a massive impact on your life! Even if you are getting married in accrual, you may want to exclude your pension/retirement/preservation funds from the accrual; if you're likely to be contributing more to them. The CPI growth on commencement values is usually less than the return earned on pension fund assets.

Note that this writeup is my interpretation of the law, and others may interpret it differently. In fact, anecdotally, given the state of the level of jurisprudence in the High Court, their rulings have increasingly become a lottery. The only 2 cases I could find which looked at the topic, have issues with them (discussed in this writeup); so my conclusions are mostly drawn directly from a read of the legislation.

Accrual System looks at the NET Estate

Your Antenuptial Contract might stipulate that there is no community of property and that the marriage is subject to the accrual system of Chapter 1 of the Matrimonial Property Act. It will then set out the nett value of your respective estates at the start of the marriage. Some important extracts from the Matrimonial Property Act:

Unfortunately, the Matrimonial Act doesn't define what is meant by "net value of his estate", in particular what it is net of. I read the use of the word "net" as logically implying that the size of the estate should be less its liabilities, including tax liabilities. Also, common sense says that one needs to look at what each spouse has in their own pocket at the end of the day (you can't give away money you don't have). 

That is how Judge Tolmay of the Gauteng High court interpreted it on the 24th February 2010: “The tax liability attached to the parties pensionable interests is a liability in their respective estates and should be taken into account in determining the nett accrual of the respective estates.” Unfortunately this is clouded by the top of the judgement saying "NOT REPORTABLE" and "NOT OF INTEREST TO OTHER JUDGES" - Nobody knows why the judge marked it like that, but I think the conclusion of Judge Tolmay is correct. It's up to judges' discretion to mark their judgement as "NOT OF INTEREST TO OTHER JUDGES". However, just like other decisions of the High Court, this decision is binding on the Gauteng High Court, and so judges sometimes unwittingly make law like this. Sometimes the reason judges mark cases as NOT REPORTABLE is because they feel the point is so obvious that it may be self-evident.

As Judge Tolmay points out: 'In the South African Concise Oxford Dictionary, the word “net” or “nett” is described as follows: “(of an amount, value, or price) remaining after a deduction of tax or other contributions.”

Stalingrad Option: Making a Lump Sum Withdrawal prior to divorce - be very careful

If your spouse does not believe you that the tax liability for your preservation fund should be taken into account, you could possibly make a withdrawal from your preservation fund (if you have not used up the one you are allowed) prior to the divorce, and pay the tax hopefully before the divorce (!); after which even your gross assets would be smaller by the amount of the tax. One needs to be VERY careful before executing the "Stalingrad" strategy; as high rates of tax are payable on lump sum withdrawals from a retirement funds; whereas you're likely to pay less tax if you wait until retirement and receive the money as annuity payments (or even most of the time lump sums at retirement). A careful calculation must be done here, to properly assess this option. But even if not executing on it, it may be worth mentioning this in the settlement negotiations if there is doubt by one party as to whether the tax liability should be taken into account.

In my case I almost had to make a lump sum withdrawal, as my spouse was insistent on a cash payout rather than receiving retirement assets, so my other alternative was to take it before a judge. Since I was only entitled to one withdrawal, I wanted to make it large enough that I had a buffer against things going wrong. If you're anyway going to make a lump sum withdrawal, the case of doing it prior to the divorce is stronger, when your spouse does not agree that tax should be taken into account.

Pension Interest is a Gross Number

The calculation of the pension interest is detailed further on in this writeup. Section 7(7a) of the Divorce Act says that the pension interest shall be deemed to be part of the assets (subject to a couple of exclusions) in the determination of matrimonial benefits. The only comment at this point is that the legislation implies that Pension Interest is a gross of tax number (the tax liability gets taken into account elsewhere).

Other Tax Liabilities must also be allowed for

This writeup focuses on the tax liability associated with the pension interest; but it is worth mentioning that just as the tax liability associated with the pension fund should be taken into account; other tax liabilities should also be taken into account. For instance there may be Capital Gains Tax payable payable on realisation of shares or sale of the house, or a large amount of money owed to the Receiver of Revenue. Once again, if your spouse doesn't want to accept that there is CGT payable on your shares, you may want to sell them before the divorce and crystalise the tax.

If you're planning on selling shares to finance your divorce settlement payment, you may find you're short of cash at the end of the day, if you didn't take into account the Capital Gains Tax you have to pay.

Pension Interest

It is easy to obtain the value of your pension interest, you merely approach your pension fund, retirement annuity fund or preservation fund and request an estimate of the pension interest. Note that the law says that the pension interest is the value as at the "date of divorce". Of course you will only know your date of divorce once it has happened; so if it is in the future the best the fund will be able to do is to say what the pension interest would be if you got divorced today.

The definition of "pension interest" can be found in two places:

  1. Section 1 of the Divorce Act.

  2. Section 37D of the Pensions Fund Act.

Section 1 of the Divorce Act says that "pension interest" in relation to a party to a divorce action who-

Crazily, for anybody who knows how interest rates work, the above definition for retirement annuity funds implies that only a single interest rate is used in the calculation, the rate prescribed on the date of divorce, even if contributions were made 20 years prior! I do wonder whether (a) this is what the legislators intended, and (b) the administrative systems of retirement annuity funds calculate pension interest in this unintuitive way.

Subsequent to "pension interest" being defined as above in the Divorce Act, a few new things were enacted in the Pensions Fund Act, as issues arose.

Section 37D(5) of the Pensions Fund Act mentions a number of things, including adding this important provision (otherwise there could be the ridiculous situation for retirement annuity funds, where the pension interest exceeds the actual amount of money available):

Of course one's membership of a preservation fund isn't terminated by resigning, so the definition in the Divorce Act doesn't make sense. So, section 37D(6) of the Pensions Fund Act contains this important detail for those in preservation funds: "Despite paragraph (b) of the definition of ‘pension interest' in section 1(1) of the Divorce Act, 1979 (Act No. 70 of 1979), the portion of the pension interest of a member or a deferred pensioner of a pension preservation fund or provident preservation fund, that is assigned to a non-member spouse, refers to the equivalent portion of the benefits to which that member would have been entitled to in terms of the rules of the fund if his or her membership of the fund terminated, or the member or the deferred pensioner retired on the date on which the decree was granted."

Actual Transfer of Pension per Divorce Order

If there is a decree of divorce that a part or all of a pension interest of a member is transferred to his/her spouse, this is covered in Section 7(8) of the Divorce Act. This and the tax on it is fairly clear from the legislation and subsequent case law; and is not the focus of this article. This article focuses on the accrual calculation.

Pension Interest is a gross of tax number

Looking at Section 2 of the Second Schedule to the Income Tax Act (you will find it amongst other Acts listed here); and I don't quote fully, merely extracting relevant bits (you should read it in its entirety if you're using this for legal purposes): "...the amount to be included in the gross income of any person ... shall be ... any amount assigned in terms of a divorce order granted on or after 13 September 2007 under Section 7(8)(a) of the Divorce the extent that the amount so ... constitutes a pension interest, as defined in section 1 of the Divorce Act, of a member of a pension fund, pension preservation fund, provident fund or provident preservation fund or retirement annuity fund; and is due and payable on or after 1 March 2012 to a person who is the former spouse of that member by that pension fund...that is transferred for the benefit of that person to any pension fund..."

This means that it is taxable in the hands of the non-member spouse who it is being transferred to, rather than the member who it is being transferred from. This further implies that the "pension interest" referred to in Section 7(8) of the Divorce Act is a gross of tax number.

As an aside, in case you're googling, this implies that the judgement delivered in 2008 in the case between the Protektor Preservation Pension Fund and Bellars et al is at least partially incorrect. In particular this extract is wrong: 'The definition of “pension interest” is to be read as including the after-tax withdrawal benefit (as defined in the rules of the preservation fund) that would be payable to a member if he or she had opted to take a total withdrawal benefit as at the date of divorce.” Also, bear in mind that this ruling was made before Section 37D(6) was written to set out the pension interest on a preservation fund asset.

Whilst the tax liability should be taken into account in the accrual calculation, it is incorrect that the pension interest is an after tax number, as demonstrated above.

Wording of Order to Pension/Preservation/Retirement Annuity Funds

It is crucial that the wording of the order from the court is correct. Decent lawyers are likely to know about this and get it right. This article does not address this issue.

How to Calculate the Pension Interest's Tax Liability

Legislation is silent on how the pension interest's tax liability for accrual purposes should be calculated; with the 2 main possibilities being to (other possibilities are to die, be disabled, having to make withdrawals as a result of maintenance claims, ....):

  1. Assume that the pension interest is paid as a lump sum withdrawal benefit (assuming divorce is before the date of retirement), This is an easy calculation.

  2. Project & Discount Future Tax: Assume the pension interest is held onto until retirement date (but which retirement date - earliest, latest, average or something else?), and then some (how much?) is paid as a lump sum retirement benefit (with the associated tax), and the remainder received as annuity payments (with their associated tax). This is difficult to calculate and assumptions would need to be made about retirement date, the amount of the lump sum withdrawal, tax bands at the date of the lump sum withdrawal, future annuity payments and the tax rate that those would attract. And then what discount rate should be used to discount the future amounts to the divorce date? But just because a calculation is difficult doesn't mean that the tax liability should be ignored - as this could severely prejudice one of the spouses. This is an area, where I think actuaries could work together with legislators, in devising a set of standard assumptions to use. But that is just a thought in my head, until that happens one would need to individually consult with an expert (e.g. an actuary) to assist with this calculation.

Whilst it may be possible to make a lump sum withdrawal from a pension or preservation fund; it is not possible to do so from a retirement annuity fund, so for RAs it seems the way to go is to project & discount future tax.

What makes the most sense to me is that the tax liability for accrual purposes should be based on the best estimate of what the parties actually intend to do. So, if:

Special Circumstances : Splitting the Assets

If the retirement assets are going to be split 50:50; and both parties plan to immediately withdraw then the tax liabilities would often be the same (if neither party has a made a prior lump sum withdrawal). Mathematically then, the difference in net accruals is the same when the tax liability is or isn't taken into account; so one doesn't have to go through the trouble and cost of estimating it.

Note that if the retirement assets are going to be split 50:50 and both parties plan to hang onto the assets until retirement; the tax liabillities are still likely to be different because of different retirement dates, amounts of lump sum withdrawals, profile of annuity payments and tax bands.

Court Decides

Ultimately, if you and your spouse cannot agree on a settlement, then an option is to ask the court to decide. As mentioned earlier, there is luck involved that the court rules in your favour, even if the legislation points in that direction.

So, you'd then tell the court that despite settlement discussions the parties could not agree to a settlement offer, and then you set out a breakdown of assets. You could also propose how the settlement offer should be paid (e.g. part cash and part as a transfer of retirement assets). You may very roughly be able to nullify the impact of the tax liability by an appropriate split of the retirement assets.

Relevance of Court Cases in other Provinces

In principle, whatever the High Court says creates law, and it does so in its own province - so the Cape High Division is bound by its own previous decisions, unless they are manifestly wrong. Decisions by High Courts in other provinces, e.g. KwaZulu-Natal and Gauteng, are persuasive and will influence the Cape court, they will look at them seriously, but they are not bound by it.

However, the Cape courts and all the provincial courts are bound by the Supreme Court of Appeal and obviously Constitutional Court decisions.

Ask the Author Question

If you have questions about this article, email

Question 1

24 August 2019. Jane wrote to me, and she contends that in the calculation of the estate for accrual purposes, it's common practice for practitioners (in Gauteng) to assume that there is a liability associated with pension interest, and that the tax liability is calculated according to the withdrawal tables in the Income Tax Act assuming a full lump sum withdrawal".  She asks on what legal grounds is a lump sum withdrawal and therefore tax assumed.

Whilst legislation defines pension interest precisely, if you read the article above, you'll see that I say that "Legislation is silent on how the pension interest's tax liability for accrual purposes should be calculated".

So, where does this assumption come from? Most likely practitioners looked to the Divorce Act, where it says that the pension interest of a pension fund "means the benefits to which that party as such a member would have been entitled in terms of the rules of that fund if his membership of the fund would have been terminated on the date of the divorce". Practitioners then seem to be assuming that the associated tax liability should be calculated on a consistent basis. I have sympathy for this view, but the Divorce Act doesn't specify how the tax should be calculated, although it would be neat for it to be done like this (but not necessarily fair). Then again, in my opinion, the legislated calculation of pension interests isn't necessarily fair either! So, don't be expecting fair when it comes to these calculations!

With retirement annuity funds, however, it's a complete nonsense to assume tax is calculated according to lump sum withdrawal tables, as:

In my opinion there is a strong case that the associated tax liability should be calculated as the Matrimonial Property Act says to look at the "net value of his estate", but the law is silent on how to do it. There are numerous ways in which the tax liability could be calculated (e.g. early withdrawal, early retirement, late retirement, ...), which makes it a complicated calculation. However, just because it's complicated doesn't mean it should be ignored. Just as for assets where we take our best estimate of the value, sometimes the same should be done for taxes. What makes sense to me is to base the tax liability for accrual purposes "on the best estimate of what the parties actually intend to do. So, if:

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