There could be huge opportunities for you to boost your retirement savings next year, when the tax deductions for retirement fund contributions are amended, Jenny Gordon, the head of retail legal support at Alexander Forbes, says.
From March 1 next year, the various tax deductions for contributions to a pension fund or retirement annuity (RA) will be simplified and replaced with a uniform deduction for contributions to all types of funds, including provident funds (see table, far right).
Currently, if your employer contributes to your pension or provident fund, it is entitled to a tax deduction of up to 20 percent of your approved remuneration. But your employer does not receive a tax deduction for contributions paid to an RA on your behalf. (Approved remuneration is that which the Commissioner of the South African Revenue Service regards as reasonable for the services you render.)
Gordon says the deduction-split between you and your employer often results in you not deriving the optimal benefit from the deductions.
From March next year, any contributions your employer makes to a retirement fund on your behalf – plus any contributions to the fund’s group life scheme – will be added to your income, and the new tax deduction – 27.5 percent – will be allowed on the combined contribution of you and your employer.
The tax deduction of 27.5 percent will become yours, rather than your employer’s, enabling you to use it fully, regardless of the extent to which your employer contributes to your retirement savings.
Very few employers currently contribute the full 20 percent of remuneration to a retirement fund, Gordon says.
Here are a few scenarios of how things might change for you:
* If you currently receive only a salary that is retirement-funding – that is, your entire salary is used to determine your pension fund contributions – you can claim a tax deduction for contributions of up to 7.5 percent of your salary.
If your salary is your only source of income, you do not have any non-retirement-funding income against which to claim a tax deduction for contributions to an RA.
If your employer contributes seven percent of your salary, the total contribution (yours and your employer’s) is 14.5 percent.
From March, if your employer continues to contribute seven percent of your salary, you will be able contribute an extra 13 percent of your salary to an RA – bringing your contribution to 20.5 percent and the total contribution by you and your employer to 27.5 percent – and claim the full amount as a deduction.
*u If you are a member of a provident fund, your contributions to your fund are currently not tax-deductible; only your employer is entitled to deduct contributions up to 20 percent of your remuneration.
From March, you will be able to deduct 27.5 percent, which means at least 7.5 percentage points more of your income than you can now, and even more if your employer’s contribution to your retirement savings and group life cover amounts to less than 20 percent of your income.
* If you are self-employed and contribute to an RA, from March you can increase your contributions from 15 percent of your income to 27.5 percent of either your taxable income or your remuneration, whichever is higher (see below).
* If you are topping up your retirement savings in your company-sponsored fund by contributing 15 percent of your non-retirement-funding income, such as your bonus, and your employer continues to contribute based on your retirement-funding income (the income on which your pension fund contributions are based), you may be able to increase your contributions by another 12.5 percent of that non-retirement-funding income.
The new tax deduction will be based on the higher of your taxable income or your remuneration, whereas currently it is based on either your retirement-funding income or your non-retirement-funding income, Gordon says.
Your remuneration includes what you earn for services rendered, such as your salary, leave pay, bonus, pension, fringe benefits and any gratuities or commission you receive before any deductions.
Your taxable income, however, includes your remuneration, any annuities you receive, rental income, any interest income you earn and any capital gains you have made. Taxable income is reduced by deductions, such as what you spend in the production of trade income.
Your taxable income may be higher if, for example, you receive a salary and interest or rental income, but your remuneration may be higher if you run a business with many expenses to deduct (see Mr X’s example, below), Gordon says.
You will no longer have to make a distinction between retirement-funding income and non-retirement-funding income and apply a different deduction to each. This is an important change, Gordon says.
She says you should find out whether, from March next year, your employer’s fund will be able to accommodate additional contributions. If it will not, you can consider putting money into an RA.
The new tax deduction for contributions to a retirement fund will be limited to R350 000 a year. This is the amount the government is prepared to incentivise, Gordon says. You may reach the limit if you earn more than R1.27 million a year.
However, even if your contributions exceed the limit, there are many reasons not to stop contributing, she says. One reason is that your goal should be to provide sufficient income in retirement, and the discipline of saving into a retirement fund is a good one to maintain.
Also be aware that the growth on and income earned from savings in a retirement fund during your membership is tax-free and that your contributions that were not tax-deductible can be deducted from a lump sum or pension income when you retire, Gordon says (see “New provision benefits retirees”, below).
If you are declared insolvent, the savings in your retirement fund are protected. Also, the costs of an occupational fund are likely to be lower than those of other investments, she says.
Example: Mr X
Mr X is in a high-paying job, plus he earns income from other sources.
* His salary is R1 million in the 2015/16 tax year.
* He sells shares and makes a capital gain of R300 000 (33.3 percent of this, or R100 000, is taxable).
* He earns rental income of R100 000 from a second property, but has related expenses of R90 000, which he can claim as a deduction.
* He sells a third property and makes a capital gain of R500 000 (33.3 percent of this, or R166 500, is taxable).
* His total taxable income is:
Salary: R1 million
Taxable gain on shares: R100 000
Rental income (R100 000 minus R90 000): R10 000
Taxable gain on sale of property: R166 500
Total: R1 276 500
* He is a member of his employer’s retirement fund, and he and his employer contribute 19 percent of his pensionable income (R142 000).
* His pensionable income is 75 percent of his remuneration (R750 000).
How much can he top up his contributions to his pension fund, and how much can he contribute to a retirement annuity (RA)?
* 27.5 percent of remuneration = 27.5 percent of R1 million = R275 000.
* 27.5 percent of taxable income = 27.5 percent of R1 276 500 = R351 071 (the deduction will be capped at R350 000).
* He currently contributes 19 percent of R750 000 = R142 000.
* From March 1, 2015, he can contribute an extra R208 000 (R350 000 minus R142 000) to an RA or to his occupational fund.
New provision benefits retirees
A new provision in the Income Tax Act that took effect in March this year presents tax-planning opportunities for people in retirement or close to it, Jenny Gordon, the head of retail legal advice at Alexander Forbes, says.
This enables you to offset against your compulsory annuity income in retirement any contributions to a retirement fund that you could not claim as a tax deduction.
Before the provision was introduced, if your contributions to a retirement fund exceeded the amount you are allowed to deduct each year, you had two options:
* Carry the excess amount over to subsequent tax years until you can deduct the contribution; or
* Deduct the excess amounts from any lump sums you withdraw from your retirement savings, either before or at retirement.
These options are still available, Gordon says. But you can now offset the excess contributions against any income you receive from a compulsory annuity (pension) bought with your savings in a retirement fund.
Assume, for example, you contribute R450 000 a year to a retirement annuity fund after 2015. Only R350 000 is tax deductible each year. After 10 years years, you will have contributed R1 million (R100 000 x 10) that you could not deduct against tax.
This can be offset against your compulsory annuity income. Assume you have retired and draw an annuity of R240 000 a year. The R1 million contribution to the RA can be offset against your income of R240 000, which means you will not pay tax on your income for more than four years.
Gordon says your annuity provider will continue to deduct tax from your annuity, and you can currently only claim these excess contributions against your income on assessment.
It is not clear whether the taxman will, in future, send you a tax directive so that you can enjoy the tax relief upfront.
Do you take a lump sum or not?
At retirement, you can, but do not have to, take up to one-third of your savings in a retirement annuity (RA) or pension fund as a cash lump sum.
There is not a one-size-fits-all answer to the question of whether you should take the lump sum (in full or in part) or use all of your savings to buy an annuity (monthly pension), Jenny Gordon, the head of retail legal services at Alexander Forbes, says. You will need a comprehensive analysis of the taxes you will pay.
If you do not make any withdrawals from your retirement savings before you reach retirement age, you can take up to R500 000 as a cash lump sum tax-free. Thereafter, withdrawals are taxed at a rate of 18 percent, 27 percent or 36 percent, depending on how much you take as a lump sum and how much you withdrew from your savings before retirement.
Gordon says you should bear the following in mind:
* Your tax rate is often lower in retirement than it is while you are working. Therefore, although you are taxed on any income paid to you from an annuity bought with savings in an RA or pension fund, it is likely that you will pay less tax than you did before you retired.
* Compare your effective tax rate in retirement with the tax you will pay on the lump sum, rather than your marginal tax rate. If you are on the top marginal tax rate of 40 percent, your effective rate is less than 40 percent.
* Each year, the tax threshold – below which you do not pay tax – increases, and the threshold is higher for taxpayers aged 75 or older. Over-65s also enjoy higher tax credits for medical expenses.
* You are taxed on the lump sum you withdraw at retirement when you withdraw it, whereas the tax on a pension bought with your retirement savings is deferred until you receive the pension. If you invest in a living annuity, the growth on the money in the annuity is tax-free.