The principle of defined contribution retirement funds is that members build up their individual retirement capital from their own contributions and from a portion of the employer's contributions, together with investment returns. In contrast with defined benefit funds where the pension benefit is pre-defined and the employer carries the risk of under contributions and poor investment returns, a member of a defined contribution fund carries these two risks and is dependent on the capital that has built up to retirement to provide income in retirement. The member is the owner of the capital and many defined contribution funds reinforce this ownership principle by offering a refund of the balance of a pensioner's retirement capital in the event of the pensioner's early death following retirement.

Two questions arise. Firstly, does the Income Tax Act make provision for this type of benefit? Secondly, what does this benefit represent and how should this type of benefit consequently be taxed?

Turning to the first question, the Income Tax Act, in the definition of preservation fund states categorically that "...if a person dies after he or she has become entitled to an annuity, no further benefit other than an annuity or annuities shall be payable to such person's spouse, children, dependants or nominees..." This does make sense as a retiree had the option of having one third of the retirement benefit paid out in cash tax-free, as a once-off concession.

Although the definition of 'pension fund' in the Income Tax Act does not contain the same provision, this is probably not the intention of the legislator. This intention is also reinforced in Practice Note 1 of 1986 that deals with flexible annuities. In this practice note it is categorically stated that no further commutation of capital may be made upon the death of the pensioner. Any remaining capital must be paid out as an annuity over a minimum term of 5 years.

Turning to the second question, it appears logical that even if the Income Tax Act does not prohibit a further commutation of any amount upon death of the pensioner for a lump sum payment, such lump sum in effect represents an accelerated payment of what would have been paid in the form of annuities had the pensioner not passed away. Such lump sum payment would thus be fully taxable. Presumably Inland Revenue would not object to receiving its tax dues immediately and calculated on a higher taxable amount as opposed to receiving its tax dues on smaller monthly annuities over a period of time.

Important notice and disclaimer
This article summarises the understanding, observation and notes of the author and lays no claim on accuracy, correctness or completeness. Retirement Fund Solutions Namibia (Pty) Ltd does not accept any liability for the content of this contribution and no decision should be taken on the basis of the information contained herein before having confirmed the detail with the relevant party. Any views expressed herein are those of the author and not necessarily those of Retirement Fund Solutions.