Divorce to withdraw Retirement fund & Tax Aribitrage

Last week we described a loophole whereby you can stage a fake divorce to withdraw your retirement funds under Government's proposed two-pot retirement system. This week we'll explain how this simultaneously opens the door for a tax arbitrage for couples with significantly different marginal rates of tax.

High Earning Husband, Stay-at home Wife

Let's consider your typical traditional 1950s married couple dynamics where:

the husband has a job with high earnings (maybe an accountant?), and a marginal tax rate of 45%.
the wife does not earn an income and has a marginal tax rate of 0% (zero).

Husband working on computer and wife ironing

Fake divorce to access retirement component

The couple are, for some reason, desperate for cash, and decide to stage a fake divorce to access the retirement component of the husband's pension fund, which has accumulated to R10m.

Certificate with "Faux Divorce" written on it, and a broken heart

Withdrawal attracts no tax

As part of the divorce order, the now ex-husband's pension fund is ordered to move the R10m to the ex-wife.
The pension fund asks the ex-wife whether she'd like the payout in cash or whether she wants it transferred to her pension fund, and she elects to have the R10m (less tax) paid out in cash.
The pension fund then requests a tax directive from SARS, in the ex-wife (non-member)'s name; and it's communicated that the ex-wife has a zero percent marginal tax rate, so there will be no tax payable.
The R10m is then paid into the ex-wife's bank account.

Why is this a Tax Arbitrage

Contributions to pension funds (within limits) are from income earned which is exempt from income tax (the husband may have had to pay up to 45% income tax on this income, if he'd not used it to contribute to the pension fund).

The alternative to the fake divorce is that the the husband waits until retirement, makes a tax-free lumpsum withdrawal (limited) at retirement and over time is paid an annuity from the rest, with the income from the annuity being subject to income tax.

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Thank you for reading to the end!

PS we are running out of time before conveyancing fees increase on 27 May 2024; if you are getting your house sold (or even just thinking of doing so at some ponit) get your conveyancing fee quote now, so as it lock in the lower rates.

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Errors or omissions expected.

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Info on Divorces & Pension Fund assets

Alongside the house being lived in; holdings in pension funds are often the biggest assets in a divorce.

NB: Under the new 2 pot system law, you must formally notify your spouse's pension fund in writing about the divorce proceedings, along with providing proof. Once this notice is given, the pension fund is legally prohibited from permitting any withdrawals, loans, or guarantees without the consent of the non-member spouse.

Proposed two pot retirement system and impact on divorce settlements:

Get your info directly from spouse's pension fund, not indirectly from your spouse.

Divorce and pension fund payouts

Undisclosed Pension Interest at divorce results in amendment to divorce order

Pension interest in the accrual calculation, and the related tax liability

When the state pension fund refused to pay

Navy pension payout post-divorce

Unmarried couples & pensions

Divorce & pension funds discussion forum

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