/ 18 June 2008

Use your divorce payment wisely

Spouses are entitled now to an immediate share of the retirement savings of their former spouse if provided in the divorce agreement.

Prior to September 2007 former spouses had to wait until the member of a retirement fund terminated his or her membership from the fund to receive their payment, with no provision for investment growth.

This was potentially unjust to the non-member spouse because his or her share was subject to erosion by inflation, unless compensatory provisions were made in other aspects of the divorce agreement.

The law has changed now and the non-member spouse has access to his or her share immediately.

This applies to divorces after September 13 2007.

This allows the non-member spouse now to invest his or her share. This is an advantage because it provides the opportunity to offset the effects of inflation.

A divorce is often a costly exercise, resulting in a reduced standard of living, so there is a temptation to access retirement funds for short-term financial needs.

But spending the money today could have a significant impact on long-term retirement goals and the tax implications need to be assessed.

Mark Cronje, advice manager at Old Mutual, says tax legislation holds the member spouse liable for the tax arising on these payments.

This is important especially if the divorce agreement does not contain an appropriate provision for such tax. Withdrawing the money might have a negative effect on the existing member’s lump-sum investment and compensation is likely to be required.

If the non-member spouse transfers the money into another retirement vehicle, no tax should be payable. Cronje says the non-member should consider these funds part of his or her retirement savings and use the funds to boost retirement savings, especially if the non-member spouse has not already accumulated a significant retirement fund themselves.

Cronje says the replacement ratio is a good measure to demonstrate the importance of saving sooner rather than later. This is the ratio of your sustainable income level after retirement as a percentage of your current salary.

For example a replacement ratio of 38% means that you will be able to sustain only 38% of your current income at retirement after allowing for inflation. A typical replacement ratio for someone retiring at 65 after contributing to a retirement fund for 20 years is about 30%.

But a replacement ratio of about 80% can be expected when retiring at 65 after contributing to a retirement fund for 40 years. Placing the lump sum received on divorce into a retirement fund will boost your replacement ratio.

Divorce prior to Sept 2007
There is uncertainty about whether people who divorced prior to September 2007 also have the right to claim divorce benefits from retirement funds.

A draft Bill, the General Financial Services Laws Amendment Bill, was submitted for comment and should help to clarify the situation. Old Mutual says that, while the principle of providing the non-member spouse with immediate access to his or her share is sound, in some divorce orders the lack of access to the funds might already have been taken into account and therefore the divorce agreement provides additional payment as part of the settlement.

The current legislation makes the member of the fund responsible for any tax payments due to the partial withdrawal of the funds by the former spouse.

The divorce agreement would have to ensure that the member is compensated for this additional taxation.