READER LETTER OF THE WEEK
YOUR MONEY: Making the most of your excess retirement payments
This week we look at how Sars applies tax deductions to excess retirement fund contributions
I contribute more than the R350,000 annual limit to my pension fund.
I see that Simon Brown writes that this is available as a tax deduction in retirement.
My question is: how does the South African Revenue Service (Sars) apply this? For example, say you have accumulated R1m in excess payments on retirement, will Sars in the first year offset the full R1m against taxable income in that year? Or do you have the choice to spread that R1m over, say, five years in retirement and have R200,000 per year as a tax deductible? (This makes a big difference in terms of the accumulated tax benefit.)
I am 55 years old and need to retire in five years. I can afford (and the rules allow me) to contribute a lot more to the pension fund, as the money in the pension fund can grow tax free. If I can decide how I want to spread the additional pension contributions, I will happily do so. But not if Sars will apply the full amount in the first year of retirement, and then just roll over the part not used in the second year, and so on.
I am delighted to read that you are optimising the benefit of “disallowed contributions”. This is an underutilised tax benefit and as with any investment portfolio, the earlier you start optimising this, the better the outcome.
You are allowed to deduct up to 27.5% of your annual taxable income contributed to a retirement fund (this can be a combination of a provident/pension fund and a retirement annuity), up to a maximum of R350,000 per year.
Any contributions saved over and above your annual 27.5% deductible amount (or R350,000 per year) are pooled in what is referred to as “disallowed contributions”, and can be optimised at retirement stage.
When reaching retirement, some or all of your retirement portfolio will be converted into a life/living annuity (or in some cases a combination of both). Referring to a living annuity, you select an income between 2.5% and 17.5%. This income withdrawal will be taxed on the normal income tax scales.
By using your disallowed contribution lump sum, you can now offset the tax payable on this income. The larger your disallowed lump sum, the longer you can essentially create a “tax-free” retirement. (Combining this with a tax-free investment over time — even better.) This benefit will be directly offset against your income earned.
As to your question regarding how Sars offsets this benefit, depending on your income earned for that year (from various sources) the full amount will be offset, therefore not making it possible to “selectively” use the benefit. Depending on your income withdrawal selected, and any other sources of income, the holistic tax offset will be done annually. Should your annual income earned be less than the million referred to, some of the excess benefit may roll over to the next year.
In terms of continuity planning, should you pass away, your beneficiaries can benefit from your living annuity as you can nominate loved ones. Your beneficiaries can select to either take a lump sum or continue the monthly income earned.
Keep in mind, however, that “disallowed contributions” will not be taken into account, as the tax exemption for annuities as set out in section 10C of the Income Tax Act will only be available to the person who actually made those contributions.
R21 Wealth Management Stellenbosch
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