Treasury plans to scrap tax on early pension withdrawals

The National Treasury building in Nairobi in this picture taken on March 15, 2023. PHOTO | DENNIS ONSONGO | NMG

The government is considering scrapping taxation on pension withdrawals by savers aged below 65 years, handing relief to those eyeing early retirement but presenting a headache for pension administrators.

The Treasury, in its revenue strategy for the medium term, revealed plans to overhaul the current pension laws that make it costly for workers to tap into their pension before hitting 65 years. The changes could come as early as July next year.

“During the strategy period, pension tax structure will be reviewed from exempt-exempt-tax to exempt-exempt-exempt to make withdrawals exempt irrespective of the taxpayer’s age,” it said in its revenue plan.

Read: Court suspends 30pc tax on lumpsum pension pay

Currently, only retirees above 65 years access their pension without paying taxes. For those aged above 50 but below 65, only the first Sh600,000 of the pension withdrawal is tax-free while the next Sh1.6 million attracts tax between 10 percent and 25 percent tax. Any amount above this is taxed at 30 percent.

For those tapping into their pension before turning 50, the first Sh600,000 is for free while Sh466,704 is taxed at between 10 percent and 25 percent, leaving the balance to be taxed at 30 percent.

An exempt- exempt-exempt structure for pension will mean that contributions towards pension (currently at a maximum of whichever is lower between Sh20,000 and 30 percent of the salary), investment income generated from pension contributions, and withdrawals by the contributors are all exempted from tax.

This will mark a departure from the current exempt-exempt-tax where pension contributions and investment incomes are exempted from tax but withdrawals are subjected to a graduated tax structure depending on the age of the contributor.

“This structure is discriminatory since pension withdrawals after attaining the age of 65 years are exempt while those below the age of 65 years are taxable,” the Treasury said.

Treasury reckons the current set-up forces people into tax planning, where they wait up to 65 years just for the sole purpose of escaping the tax that is tied to early withdrawals.

The move, while presenting a huge tax saving for those wishing to access their pension before 65 years, has drawn mixed reactions from industry experts.

“People opting for early retirement will be saved from taxes but I expect to see a threshold of 50 or 55 years being set to avoid the abuse of this window. Otherwise, pension schemes’ cash management will be a big nightmare given that they make long-term investments,” said Robert Waruiru, tax and regulatory partner at Ichiban Tax & Business Advisory LLP.

Treasury said, without giving details, exempt contributions to the pension scheme “shall be restricted to a threshold to cushion tax planning.”

“I suspect the government will lower the exempt threshold or retain it at the current Sh20,000 which has been in existence for about 13 years to avoid taking a big hit,” said Mr Waruiru.

The Kenya Revenue Authority currently allows tax relief of up to Sh20,000 per month for amounts contributed to a registered pension scheme. Pension and lump sum payments after the age of 65 are tax-free.

For those over 50 years but below 65 years and have been members of a scheme for more than 15 years, the first lump sum withdrawal of up to Sh600,000 is tax-free while the rest is taxed at a graduated scale where the first Sh400,000 attracts 10 percent tax.

The next Sh400,000 for such a person is taxed at 15 percent, followed by 20 percent on the next Sh400,000. The next Sh400,000 is taxed at 25 percent while the balance is hit with a 30 percent tax.

If one is below 50 years of age and has been a member of a pension scheme for less than 15 years, the first lump sum withdrawal of up to Sh600,000 is tax-free while the first Sh121,968 is taxed at 10 percent, followed by 15 percent on the next Sh114,912.

Read: Pension fund returns increase to 6.4 percent

A further Sh114,912 for such a person attracts 20 percent followed by 25 percent for another Sh114,912. The balance is then hit with a 30 percent tax.

Mr Waruiru said the proposal for full tax exemption will also ensure amounts above Sh20,000 are not subject to tax at the point of withdrawal since it is already contributed on amounts net of tax.

Sundeep Raichura, the chief executive at Zamara Group, said allowing early access while holding or cutting the tax exemption amount to Sh20,000 will discourage pension savings and make people look for alternatives like unit trusts.

“If you reduce tax exemption for pension contribution, you are not going to encourage long-term savings. People would rather put their money in unit trusts where they can access the money any time and withholding tax is 15 percent,” said Mr Raichura

“They need to increase the minimum tax-exempt contribution significantly as an incentive to long-term saving. If you reduce, you will kill the pension industry. No one will want to save in pensions.”

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