When it comes to protecting your nest egg, take into consideration the effect of tax relief on your savings. Picture: 123rf.com
When it comes to protecting your nest egg, take into consideration the effect of tax relief on your savings. Picture: 123rf.com

Time is of the essence if you want to make the most of tax breaks available to retirement fund investors each year to boost your retirement savings.

If you haven't made the most of the tax deductions for retirement savings and you want to top up your savings before the tax year ends, you need to contribute an additional amount to your existing fund or start a new one within the next week, as it takes about a week for the application to be processed, says Lisa Griffiths, associate director at BDO Wealth Advisers.

Saleem Sonday, head of group savings at Allan Gray, says that by contributing to a retirement fund (pension fund, provident fund or retirement annuity) or a tax-free investment you can access attractive tax-saving benefits.

Both offer you tax-free growth on your savings, which can save you lots in tax, but contributions to a retirement fund have the additional benefit of being tax deductible.

If you contribute to a retirement fund before the end of the tax year, you could get back some of the tax you have paid to the South African Revenue Service (Sars) when you file your tax return, and you can use this saving to boost your contributions.

For contributions to a retirement fund you enjoy a tax deduction up to an annual amount of 27.5% of the greater of your taxable income or remuneration. The benefit is capped at a contribution of R350,000 annually. However, if you invest more than this, you can still get the tax benefit in the future, says Sonday.

Contributions for which you do not enjoy a deduction during your working years can be deducted at retirement, and growth on them is tax free, but you may pay tax on the pension you draw.

There are different types of retirement funds. You can either be invested in a pension or provident fund through your employer as a condition of employment, or you can invest in a retirement annuity (RA) in your personal capacity (sometimes these are set up by your employer on a group basis).

You contribute to a retirement fund with pretax earnings, which means you can reduce your taxable income, subject to the annual limits, while saving for retirement. If your employer facilitates your retirement fund contributions, you may pay less tax each month. If you contribute to a retirement fund outside of your employment, such as an RA, you may get a refund from Sars at the end of the tax year.

If you have already invested in an RA, you can make an additional contribution at any time. If you are invested in a pension or provident fund through your employer, you may, depending on the rules of the fund, have the option of making an "additional voluntary contribution". The additional contribution must go through your employer and typically employers cater for additional lump sums to be deducted from annual bonuses, says David Gluckman, head of special projects at Sanlam Employee Benefits.

Michael Prinsloo, managing executive of research and product development at Alexander Forbes, says some umbrella funds cater for additional contributions but you will have to comply with Fica (Financial Intelligence Centre Act) requirements and declare the source of the funds.

Unpacking the tax savings

The investment return (interest, dividends and capital gains) you earn within a retirement fund is completely tax free. Because the growth of your money in the product is not taxed, your investment value over the long term could end up being far higher than, for example, the same sum placed in a basic unit trust investment, where your return is taxed at your marginal tax rate, Sonday says.

There are different rules for the different products at retirement.

When you retire and take your money out of your retirement annuity or pension fund, you must transfer at least two-thirds to an investment that will provide you with an income in your retirement. This transfer is tax free. If you are invested in a provident fund you can currently take the full amount as cash although changes have been suggested. Any money you take from a retirement fund in cash is taxed according to the retirement fund tax table. This allows you to get up to R500,000 tax-free at retirement or if you are retrenched at any time.

Your income in retirement will be taxed according to your marginal income tax rate at the time. If you have excess retirement fund contributions that you have not deducted for tax purposes remaining when you retire, these may be used to reduce your tax bill if you take a cash lump sum, or when you receive annuity income.

Therefore, Sonday says, you should not be deterred from contributing as much as you can afford, even if it falls above the maximum annual tax-deductible amount, as you will receive the tax benefits at some point. You should, however consider the potential benefit of investing without the limits retirement funds have on exposure to offshore markets and equities.

Jenny Williams, senior consultant wealth management at financial services company GTC, says you need to bear in mind that the 27.5% tax deduction (up to R350,000) includes contributions that you make to your employer-sponsored retirement fund. Employed South Africans typically save 10%-15% of their taxable income, including salary, commission and overtime, in their employer-sponsored funds. This allows them to contribute an additional 12.5%-17.5% to benefit from the tax relief.

RAs are also beneficial in estate planning because they are excluded from your estate for estate duty calculation purposes. Once you reach retirement age you have the option of buying a life or living annuity to provide you with a monthly income in retirement. Furthermore, the value of the living annuity is excluded for estate duty purposes.

The only downside of an RA is that you cannot access your savings in your RA fund before the age of 55 unless you are officially emigrating, and then you will pay tax on the withdrawal, says Williams.

Impact on your long-term savings

Consider the example of two investors, one earning R30,000 a month and the other R50,000 (see the table).

If they each save R5,000 a month between the ages of 25 and 60, the investment over the 35 years would be worth R7m for each, if it earns 7% a year, but the higher-income earner enjoys a greater tax benefit because this investor pays a higher rate of tax.