Contributions to retirement funds are tax deductible, within certain limits. The maximum tax deduction you may make in a tax year is limited to the greater of 27.5% of taxable income or remuneration from your employer, subject to an annual ceiling of R350 000. On 1 March 2016, the tax deductions for retirement savings increased from 15% to 27.5% - which means you can now save more for retirement and get back more from SARS.
How to minimise taxable income
If you contribute more than the limits, your excess contributions can be used to decrease the tax you may need to pay on any cash lump sum you take before, or at retirement age, or to reduce the taxable portion of your living annuity income in retirement. Contributions above this limit made directly by your employer are also taxable as a fringe benefit in your hands, but the contributions are also deductible in your hands too, subject to the annual limits.
Excess contributions in one year can also be carried over and deducted in the next year. Even if you are a member of a company pension or provident scheme, you can set up a retirement annuity to supplement your existing contributions, which are tax deductible.
If you are contributing to a modern retirement annuity (RA), like those offered by Allan Gray, you can stop and start your RA payments as often as you want, and the investment is held in your name (even if you get it through an employer).
How much should I save?
A well-researched rule of thumb is that a retirement income of 75% of your final salary just before you retire, will allow you to live comfortably during your retirement years. You may be questioning what's in it for you? Especially as saving more means less disposable income today. The important thing to remember is that a contribution made to a retirement annuity is still your money, even if you can’t spend it immediately.
You may think that you do not need to save a lot of money now in order to achieve this goal, as retirement is so far away. However, assuming a reasonable rate of return, a 30-year old who has not yet started saving for retirement, needs to save about 22% of their salary to retire comfortably. This percentage increases to 30% for a 35-year old starting to save. It is never too late to start saving for retirement.
Here is an example that demonstrates the benefits of starting to save now. Mr. Smith, who is 30 years' old, earns a salary of R300 000 per year and has a choice between keeping his retirement savings at 15% (like last year) or increasing it to the new maximum of 27.5%.
Scenario 1: Mr. Smith’s retirement savings contributions and tax bill from 1 March 2018 to 28 February 2019 if he sticks to 15%
Salary: R300 000
Retirement contribution: R300 000 x 15% = R45 000
Taxable Income: R300 000 – R45 000 = R255 000
Annual tax paid: R35 253+ 26% x (R255 000 – R195 850) = R50 632 – R14 067 (primary rebate) = R36 565
Scenario 2: Mr. Smith’s retirement savings contributions and tax bill from 1 March 2018 to 28 February 2019 if he increases to 27.5%
Salary: R300 000
Retirement contribution: R300 000 x 27.5% = R82 500
Taxable income: R300 000 – R82 500 = R217 500
Annual tax paid: R35 253+ 26% x (R217 500 – R195 850) = R40 882 – R14 067 (primary rebate) = R26 815
By taking advantage of the tax deduction limits, Mr. Smith can save an additional R9 750 on his annual taxes. Although contributing more to his retirement savings at an earlier age, means that his annual take-home pay will decrease, less of his money will be lost to tax. Remember that your retirement contributions are still your money, whereas tax paid is effectively the government’s money.
Another way of looking at this is that by giving Mr. Smith a tax bill that is almost R10 000 lower, SARS is paying almost 12% of his retirement contributions for the year. You too could benefit from this today by considering to increase your contributions to your retirement savings.
Other things to consider
Not everyone can afford to save 27.5% of their income towards retirement, but the more you save, the better your position will be in retirement.
Like most countries, South Africa has a progressive personal tax regime. Our tax rates put a heavier tax burden on those who should be able to afford it best, those who earn the highest salaries. If you are lucky enough to be earning a salary above the highest tax bracket, you will save 45% in tax on an extra rand saved in a retirement fund, whether it be in the current tax year or at some point in future.
If you are planning to make use of the tax concessions for this tax year by starting a new retirement annuity, or by making an additional contribution to an existing account, please make sure we receive your instruction, supporting documents and payment well in advance of the 28 February deadline.
This article was published on the Allan Gray Website on 08 February 2017.