With the 2018 tax year for individuals drawing to a close, investors have a final opportunity before the end of February to reduce their taxable income and pay less tax by contributing to a retirement annuity.
Why a retirement annuity?
Individuals can contribute up to 27.5%, capped at R 350,000 per year, of their taxable income to a retirement fund and use that contribution to reduce their taxable income and as a result reduce the tax they have to pay. A ‘retirement fund’ means a pension or a provident fund, or a retirement annuity. This means that even if an investor already has a pension or provident fund, he/she can still make a contribution to a retirement annuity to reduce their tax liability.
What is a retirement annuity?
The modern retirement annuity can be described as a “pension fund for the individual”. It is a flexible, cost-effective, and transparent investment vehicle. The investor is the owner of the retirement annuity and he or she can choose the underlying funds in which the retirement annuity invests, depending on individual needs and the risk profile of the investor. The investor also has the option to stop or change contributions and can make an additional contribution at any stage.
One of the biggest benefits of a retirement annuity is that the contributions to a retirement annuity are tax deductible. There is also no tax within a retirement annuity, meaning an investor gets the full benefit of untaxed growth. This gives investors a great opportunity to reduce their tax and to save for their retirement at the same time. A retirement annuity also does not form part of the investor’s estate, meaning there is no estate duty or executor’s fee payable on a retirement annuity.
How do I proceed to make the most of this opportunity?
We will gladly assist you with the necessary calculations and recommendations. Read more for some examples of how retirement annuities can reduce your income tax or how compound growth can increase your savings over time.
Examples to illustrate how contributions to a retirement annuity could generate tax savings:
(i) Brian, age 29, earns an income of R300,000 per year. He can keep the contribution to his retirement savings at 15% or increase it to the new maximum of 27.5%.
Scenario 1: Brian contributes 15% (2018 tax year)
- Salary: R300,000
- Retirement contribution: 15% (= R45,000)
- Taxable income: R300,000 – R45,000 = R255,000
- Annual tax paid: R37,474.20
- Calculation: R34,178 + 26% x (R255,000 – R189,880) = R51,109.20 – R13,635 (primary rebate) = R37,474.20
Scenario 2: Brian increases his retirement contribution to 27.5% (2018 tax year)
- Salary: R300,000
- Retirement contribution: 27.5% (= R82,500)
- Taxable income: R300,000 – R82,500 = R217,500
- Annual tax paid: R27,724.20
- Calculation: R34,178 + 26% x (R217,500 – R189,880) = R41,359.20 – R13,635 (primary rebate) = R27,724.20
By taking advantage of the new tax deduction limit, Brian can now avoid having to pay an additional R9,750 on his annual tax.
(ii) Prudence, also age 29, earns R1,500,000 per year. She decides to make an effort this year by contributing the full allowable R350,000 deduction to her retirement savings.
Prudence contributes the new maximum (27.5% or R350,000) to a retirement annuity (2018 tax year)
- Salary: R1,500,000
- Retirement contribution: R350,000 (maximum allowed as a deduction)
- Annual tax paid: R376,489
- Take home pay: R771,725 (UIF deducted and rebate taken into account)
Prudence paid herself R350,000 in saving this amount towards her retirement. In the process Prudence paid R143,501 less tax in a single tax period, since she paid her final tax on a much lower annual income.
Result
Even though contributing more to your retirement annuity will decrease your take-home pay, these contributions are made to yourself to generate money for your enjoyment at a later stage – as opposed to paying tax once-off to SARS. Either way, you will need to make payments, rather make some of them to yourself by investing in a retirement annuity!
Other advantages of retirement annuities (RA’s)
There is no limit to how much you can contribute to a retirement annuity. Contributions of up to 27.5% of your gross remuneration or taxable income (whichever is higher) in respect of your total contributions to a pension, provident or retirement annuity fund, subject to an annual limit of R350,000 are deductible. Excess amounts (above 27.5% or R350,000) contributed can be added to the tax-free portion of the lump-sum that is paid out when you retire or when the retirement annuity matures. Even though you cannot claim an income tax deduction for such excess contributions in the year the contributions are made, there is still no tax charged on interest income, dividend income or capital gains in the retirement annuity itself. This still generates a substantial tax advantage especially if the effect of compound growth over time is also taken into account.
Compound growth
Saving for retirement does not have to rely only on paying less tax because of contributions to a retirement annuity. You should also take the positive impact of compound growth on long-term savings into account.
Example
Jeremy at age 19 starts investing R2000 each year (less than R170 a month) for the next eight years. He manages to achieve a 12 percent return on this investment over time. At age 26 his responsibilities have grown and he needs more disposable income. He stops investing, leaving the investment to grow. The total amount invested at this stage is R16,000.
His friend, Patience suddenly realises she has some catching up to do. At 27 (just when Jeremy stops investing) she decides she’ll invest the same amount (R2000) per year. She keeps this up until she is 65. She has therefore invested R78,000 (R2000 per year for 39 years). Both Jeremy and Patience achieved 12 per cent returns on their investments over time.
HOWEVER, at age 65, Jeremy has R2,289,000 available (after a total of 8 years of saving only ± R170 per month) and Patience has R1,532,182, for which she has had to save the same amount as Jeremy annually, but for 39 years! The effect of compound growth is truly amazing. Even if you think the amount you can afford to save per month is very little, growth over time will make all the difference to the final result.
Capitalize on payment flexibility of RA’s
Something else to keep in mind: it can be very helpful to decrease contributions to an RA temporarily if funds are tight. However, the opposite is also true. It will make a great difference to your financial position at retirement if you increase your contribution to a retirement annuity. From the compound growth example above, it is clear that even a small amount can make a huge difference, given enough time.
RA’s for the self-employed
The flexibility of contributing to a retirement annuity makes this the investment of choice for someone who is self-employed. Depending on cash flow and income, contributions can be increased. This will make things much easier come February. Also, remember to stick to the minimum amount originally decided on, since generating a lump sum in February (just before the tax year-end) is not always manageable, even if necessary – if this lump sum is needed for tax relief!
Conclusion
It is clear from the above examples with regard to tax-benefits and compound returns on growth, that the basis for a financially comfortable retirement is to start saving as soon as possible and to take advantage of all tax savings opportunities, also those offered by retirement annuities.
Contact us if you need advice or information on retirement annuities and the tax and savings benefits available – or just about being better prepared financially for retirement.