The end of the tax year is approaching rapidly. If you want to take full advantage of the annual tax breaks and concessions afforded you by the South African Revenue Service (SARS), you have two weeks to do so. The taxman’s most generous concessions apply to your retirement savings, but there are other ways you can reduce what you pay in tax.
Subject to certain limits, you can deduct from your taxable income your contributions to a pension, provident or retirement annuity (RA) fund. On top of that, all returns earned within the retirement fund are tax-free.
Until the end of the 2015/16 tax year, you were permitted to deduct your contributions up to 7.5 percent of the pension-funding portion of your salary, and your employer could contribute another 20 percent to claim a tax deduction. In addition, on any contributions made to an RA from income not included in the pension-contribution calculation, such as bonuses or freelance work, you could claim a deduction of up to 15 percent.
For the 2016/17 tax year, which ends this month, the contribution regime was revised and simplified to give you a greater incentive to save for retirement. Now you can claim a deduction of up to 27.5 percent of your total taxable income or remuneration, whichever is higher, capped at R350 000 a year.
Allan Gray’s tax specialist, Carla Rossouw, says this means that, if your annual contributions have not reached 27.5 percent of your income or remuneration, you have until February 28 to top them up, and you can do this by putting a lump sum into an RA or into your pension or provident fund if its rules allow.
Say your cost-to-company for the tax year was R600 000, including a bonus, your employer’s contributions to your pension fund and other fringe benefits. You paid R10 000 a month (your and your employer’s contributions combined) into your pension fund, totalling R120 000 for the year. This is 20 percent of your remuneration, which means you can contribute 7.5 percent (R45 000) to a retirement annuity to take full advantage of the tax deduction.
Instead of paying income tax on R480 000 (R600 000 – R120 000), you will pay tax on R435 000 (R600 000 – R120 000 – R45 000).
Assuming no other deductions or credits for medical expenses, but including the primary rebate for people under the age of 65, according to the tax tables for 2016/17 you will pay income tax of R93 060 instead of R109 260. So in making an investment of R45 000, you will save R16 200 in tax.
What is the difference between remuneration and taxable income?
Richard Carter, the head of retail products at Allan Gray, explains that remuneration is what you receive from an employer; taxable income includes other forms of income, such as rental, interest and capital gains. (In rare cases, this other income could be negative; hence SARS’s stipulation, “the higher of remuneration or taxable income”.)
• Rental: the taxable portion is your income less your expenses from renting out a property.
• Interest: the taxable portion is the amount that exceeds your annual exemption (R23 800 a year for people under the age of 65, R34 500 a year if you’re 65 or older).
• Capital gains: Except when you sell your primary residence, the taxable portion of an annual capital gain for an individual is 40 percent of the amount over R40 000 (the annual exclusion for individuals). For example, if your gain on the sale of a second property is R500 000, the taxable amount is 40 percent of R460 000, or R184 000. Although you will pay capital gains tax (CGT) on this amount, you can include it in your total taxable income for the purposes of calculating the 27.5-percent maximum deduction. Using the example above, your taxable income would increase to R784 000 (R600 000 + R184 000, assuming no other taxable income), so your maximum allowable deduction could total R215 600. Remember, Carter warns, the R350 000 cap on the tax deduction for retirement savings will kick in for high amounts. However, contributions that are not deductible can be carried over to be deducted in a subsequent year of assessment or you will receive the amount not deducted as a tax-free benefit when you retire.
• Dividends: Local dividends are not included in taxable income, as they are exempt from normal income tax, although taxable foreign dividends (in excess of an exemption) are included.
Rossouw says that, although an RA offers a tax break now, while saving, you will pay tax later, when you draw a pension. However, when you pay income tax on your pension, you are likely to be taxed at a lower rate than when you were contributing, which is where the potential additional tax savings come in. You can withdraw up to one-third of your savings in an RA as a lump sum when you retire (the minimum age is 55), but the rest must be used to buy a pension. The first R500 000 of the total lump sum from all your retirement funds is tax-free, Rossouw says, although this figure includes pre-retirement withdrawals on retirement savings.
TAX-FREE SAVINGS ACCOUNTS
These allow you to invest up to R30 000 a year (up to R500 000 over your lifetime) and benefit from investment growth free of dividends tax, income tax on interest and CGT, Rossouw says. If you haven’t taken advantage of your R30 000 allowance for the 2016/17 tax year, now is the time to do so.
Although tax-free savings accounts do not match contributing to an RA in terms of tax deductions (you use after-tax, or discretionary, money), a positive feature is that you have access to your savings, whereas with an RA you have no access before the age of 55, except in very specific circumstances, Rossouw says. Note, however, that if you do withdraw money from a tax-free savings account, you cannot replace the money you have withdrawn, she says. In other words, you are still limited to contributing R30 000 a year and R500 000 over your lifetime.
• Donation allowance: You have an annual donations tax allowance of R100 000 a year. On anything over R100 000, you pay a flat tax of 20 percent. The only donations you can make tax-free are those to your spouse (any amount) and those to public benefit organisations of up to 10 percent of your income. Carter says you could, for instance, use your allowance to donate to tax-free accounts for your children. If you donate or transfer income to a child under the age of 18, the income from the investment will be deemed by SARS to be yours and will be taxed in your hands, but the first R100 000 is free of any donations tax, as indicated above.
• CGT exclusion: When you switch investments – for example, from an equity unit trust fund to a multi-asset fund – that are not housed within either a retirement fund or tax-free savings account, even under the same investment platform or asset manager, you become liable for CGT on the taxable gain on your investment. Each year, you can realise R40 000 of capital gains without paying CGT. If you are likely to make a capital gain of more than this, you may consider switching some investments, from time to time, to use your CGT exemption and reset the base on which the gain is calculated. However, you should switch only if it will fit in with your overall investment strategy. You should not switch simply to avoid tax. [email protected]