Top up retirement savings now

PF 26Jan pg1 update IOL PF Illustration: Colin Daniel

You have a month left in which to take advantage of Finance Minister Pravin Gordhan’s annual tax break – an incentive to help you to fill up your retirement savings bank at a big discount.

Gordhan’s offer to reduce your tax liability for the 2012/13 tax year expires on Thursday, February 28. This annual offer is on a use-it-or-lose-it basis.

You cannot leave it until the last day of February to activate, because you need time to do your calculations, gather the money and get the transaction completed before the deadline expires.

If you are a big bucks earner, you will be on the top marginal income tax rate of 40 percent. Being allowed to deduct a maximum of 15 percent of your non-pensionable income for retirement savings means in effect that the Finance Minister is paying 40 percent of your contributions.

Even those on lower tax rates benefit – but not as much. For example, if you are on a 30-percent marginal rate, you get an effective 30 cents in the rand of what you contribute to your retirement savings.

The reason is that you are not paying tax on the contributions.

Until four years ago, this tax break was limited to people under the age of 70. Now it applies to everyone.

It is not that you never pay tax on your retirement savings – you do, but only when you draw the money as a pension in retirement.

But the tax breaks do not end with claiming a deduction against your taxable income. Retirement savings are packed with other tax breaks, including:

* Investment growth on deferred tax. By investing in a retirement savings vehicle, you are effectively deferring paying tax until you withdraw the money as a lump sum and/or a pension. The money you save is earning tax-free returns, with the returns in turn compounding for as long as you leave the money invested.

* Tax exemptions. The underlying investments in tax-incentivised retirement vehicles are not subject to capital gains tax (CGT), which has a top effective rate of 13.3 percent; or income tax on foreign dividends and interest, which has a top marginal rate of 40 percent; or the newly introduced dividends withholding tax, at 15 percent. This is an advantage over other savings products, which are subject to income tax, CGT and dividend withholding tax either in your hands or in the hands of the portfolio/product manager.

* Lump-sum exemptions. At retirement, the first R315 000 of any lump sum you take from a retirement fund benefit is tax-free. The next R315 000 is taxed at 18 percent, the next R315 000 at 27 percent, and any further amount is taxed at 36 percent. These amounts are cumulative and cannot be claimed more than once.

* Delayed tax on pensions. Any amount used to buy a pension is taxed only as and when you receive your pension payments, again deferring tax and providing you with additional tax-free returns.

* A lower marginal rate. Many people are taxed at a lower marginal rate once they reach 65 because of the pensioners’ secondary rebate and a lower income. This means you are paying less tax on a rand than you would have paid when you earned it.

* Estate benefits. When you die, your savings in a tax-incentivised retirement vehicle can be paid directly to your dependants or beneficiaries, either as a lump sum or as an annuity (regular income stream). This means it will be exempt from estate duty. If your heirs select an income stream, they will pay income tax at their marginal rate, but the capital amount will continue to accumulate tax-free returns. (Note: It is important to name dependants or beneficiaries to assist the fund trustees in the distribution of your accumulated benefits if you die before retirement. After retirement, where there is a capital residue available to beneficiaries, you decide, without interference, who gets the money on your death.)

Getting the best out of the tax breaks is not the only advantage you get by topping up an RA – you are also improving your probability of a financially secure retirement. This is the intention of the incentives.

A financially secure retirement is something very few working South Africans achieve, mainly because they do not save enough for long enough and often withdraw their savings along the way.

INVESTMENT VEHICLES YOU CAN USE

The two main ways to save for retirement and take advantage of Finance Minister Pravin Gordhan’s tax incentives are through occupational and voluntary retirement funds.

If you are a member of an occupational retirement fund (normally sponsored by an employer or a trade union), you may deduct from your taxable income your contributions to the fund of up to 7.5 percent of your retirement-funding income (retirement-funding income normally excludes income such as a travel allowance). Employer contributions, which can be as high as 20 percent of your retirement-funding income, are not taxed or included in the calculation of your contributions.

Even if you are a member of an occupational fund, you can save more for your retirement through a voluntary fund such as a retirement annuity (RA).

If you are saving money in an RA, you may deduct from your taxable income the contributions you make to that RA of up to 15 percent of your non-retirement-funding income.

In other words, exclude the portion of your pay that is used to calculate your contributions to your occupational retirement fund. Add up any other income you may receive – from sources such as a travel allowance, overtime, interest earnings and moonlighting as a maître d at your local restaurant – to calculate the maximum amount you are allowed to deduct from your taxable income.

If you already have an RA to which you are contributing on a monthly basis, you should check that you are receiving the maximum benefit. Most RA funds allow you to make once-off additional contributions.

IT WILL BE DIFFERENT FROM MARCH 2014

On March 1, 2014, a new retirement savings tax regime will come into force. The following will apply. If you are:

* Below the age of 45, you will be able to claim as a deduction total maximum contributions to all funds (for example, an occupational and an RA fund) from all sources (member and employer contributions) of up to 22.5 percent, on the higher of your employment or taxable income, with a R250 000 annual limit.

* Aged 45 and older, you will be able to claim as a deduction total maximum contributions to all funds from all sources of up to 27.5 percent, on the higher of employment or taxable income, with a R300 000 annual limit.

In both cases, employer contributions will be added to your taxable income as a fringe benefit.

Also see column by Bruce Cameron: “Think before ditching your RA”


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