How to use tax deductions to boost retirement savings
If you don’t have cash now, consider contributing a little more each month next year to reduce the tax you pay
February is the last month of the tax year and you may see lots of offers to invest in either a retirement annuity or a tax-free savings account to save on tax.
It’s only really an option for those who have additional cash in the month of February, which isn’t the case for many who have just survived to the end of Janu-worry.
But it is a good time of year to assess whether you could have made more of the tax deductions you enjoy to boost your retirement savings.
You are entitled to a tax deduction for any contributions made to your retirement fund or funds of up to 27.5% of your taxable income or remuneration, but limited to R350,000. A deduction enables you to reduce the amount of income on which you pay tax. The R350,000 limit is one that will only affect someone earning over R1.2m a year.
For most people, contributing more than a quarter of their income to retirement savings will be a struggle and so you are probably contributing less than the maximum you can contribute and still enjoy a deduction. Most employer-sponsored funds are set up for contributions between 12% and 15%.
This is why if you are one of those rare people with cash to spare at this time of year, you should top up your retirement savings.
If you belong to an employer-sponsored retirement fund or an umbrella fund that your employer contributes to on your behalf, you need to check if the rules of the fund allow you to make an ad-hoc additional contribution in February.
If not, you need to open, or top up, your own retirement annuity.
But, if you don’t have cash now, do the calculation and check it again after the budget later this month to see if contributing a little more each month next year won’t make a difference to the tax you pay.
If you do not already have an automatic increase in contributions set up, ask your employer or your retirement annuity (RA) provider to increase the amount you contribute from March.
Your tax rate and the contribution you make will determine the tax saving.
For example, for this tax year, if you earned between about R200,000 and R300,000 a year, your tax rate is 26% and you can save 26% of whatever you contribute to an RA before the end of February — for example, a R500 contribution before tax year will save you R130.
If you earn between about R300,000 and R420,000 a year, you could have saved 31% of every rand you contributed to your retirement savings — or in the case of a R1,000 top up before the end of February, R310. If you use this saving to further boost your retirement savings, it will enhance your retirement income.
Alternatively, use the tax saving to offset a higher contribution — remember if you save through your employer you get an immediate tax saving on your salary. If you save on your own in an RA, you need to claim the deduction at the end of the tax year and only if your taxes are up-to-date, will you get a refund from the SA Revenue Service.
In both your retirement fund and a tax-free savings account, you can enjoy returns that are free of dividends tax, tax on interest and tax on the capital gains.
The difference between the two investments is that contributions to a retirement fund enable you to make a tax deduction whereas contributions to a tax-free savings account are made with your after-tax income.
The reason why investment companies urge you to contribute to their tax-free savings accounts in February is because you can only contribute R33 000 to one of these accounts each year. If that is a limit you are unlikely to get to in a tax year, you don’t need to worry about making the most of each year’s limit in February – just contribute as much as you can when you can.
Money in tax-free savings accounts can be withdrawn at any time, but remember there is an overall limit on contributions of R500 000 in a lifetime and if you are depositing larger amounts and drawing them out frequently, you could potentially use up that limit.
Money saved in your retirement fund should ideally not be accessed until you retire – if you change jobs you can access the cash but you should rather preserve your savings for retirement. If you are saving in an RA, you cannot access your savings until age 55.
When you access your retirement savings, you will pay tax, but at retirement there are generous tax concessions, like the first R500 000 drawn as a lump sum being tax free and your monthly pension will be taxed at a lower rate when you reach 65 and enjoy additional tax rebates.