By Gielie de Swardt, head of Retail Distribution at Sanlam Investments
When it comes to tax, government rewards taxpayers for making choices that benefit society. Donating money to approved charitable organisations is one way to get some tax back from SARS; paying family members’ medical aid contributions is another way. These expenses are purely altruistic, though, and do not contribute to your own material wealth. But there is a way to build your own investment portfolio and be rewarded with a tax refund. Contributing to a retirement annuity (RA) holds the best of both worlds: build long-term wealth and reap the tax benefits.
Why would SARS reward RA investors with a tax refund?
SARS rewards you for contributing to a retirement fund now so your older self does not become dependent on the state – or society – in retirement. Therefore, since 2016 you can contribute up to 27.5% of your total annual income to a retirement fund (the contribution is capped at R350 000) and get a tax refund. Examples of a retirement fund is a pension fund, a provident fund and an RA.
An RA has other benefits too
An RA has several benefits other than a tax refund on annual contributions: no tax on interest, dividends or capital gains while you remain invested; protection against creditors; and protection against yourself (you can’t touch the money until age 55) – to name a few. A new-generation RA also allows you to stop your contributions at any time and take it up again at a later stage. We’ve created an RA infographic to show all the main tax and other rules of an RA, such as the withdrawal limits when you retire and the deferred tax, but in this article we’ll focus only on the aspect of an RA that we receive the most questions on: how does the tax relief on contributions work?
We’ll show you with a few examples how your RA contributions can affect your annual tax bill.
Examples of how an RA provides tax relief
To keep the calculations simple and to focus solely on the tax relief offered by saving for retirement, we assume in all our examples that you had no other tax-deductible expenses, such as medical aid premiums, and made no donations to public benefit organisations. We also assume that you are younger than 65. After age 65 you enjoy higher tax rebates.
Example 1: You earn R500 000 and contribute 15% to an RA
Using the SARS 2019/20 tax tables and current primary rebate of R14 220, we calculate that you would have paid income tax of R113 655 if you didn’t contribute any amounts to a retirement fund. However, your 15% contribution to an RA (0.15 x 500 000 = 75 000) reduces your taxable income from R500 000 to R425 000. As a result, you need to pay income tax of only R86 655, not R113 655. This means, if you earned R500 000 during this tax year, your 15% contribution to an RA saves you R113 655 – 86 655 = R27 000 in tax!
Is an RA worthwhile if you are already contributing to your employer’s fund?
What if you’re already contributing to your employer’s pension or provident fund? Is it worth contributing to a private RA too? If you haven’t yet maxed out your 27.5% allowance, yes, you definitely want to consider an RA too.
Example 2: You earn R500 000 and contribute 10% to your employer fund and 15% to an RA
If you earned R500 000 in the 2019/20 tax year and you’re already contributing 10% to your employer’s retirement fund, adding another 15% to an RA will lead to a meaningful additional tax saving.
Again, using the SARS 2019/20 tax tables, we calculate that you would have paid income tax of R95 655 if you contributed 10% to your employer fund only. Your additional 15% contribution to an RA (0.15 x 500 000 = 75 000) reduces your taxable income from R450 000 to R375 000. As a result, you need to pay income tax of only 71 069.50, not R95 655. This means your 15% contribution to an RA saves you an additional R95 655 – 71 069.50 = R24 585.50 in tax.
How you use your tax refund is up to you
We’ve captured the impact of the tax relief from an RA in the infographic below. If you earn R250 000 per year and contribute 15% of it to an RA, you get R9 750 of tax back; at a total income of R500 000 per year, this increases to R27 000; and for those earning seven digits the tax refund will be at least R61 500 for the 2019/20 tax year – if you contribute 15% of your total income to an RA.
How you use your tax refund is entirely up to you. Settling any debt that you may still have first is always a good idea. Or you can use it as a deposit towards your first home or to pay for your child’s education fees. Another great use of a tax refund is to invest it in a tax-free savings account, bearing in mind that the annual limit on tax-free account contributions is R33 000 per tax year.
Remember to submit your RA certificate
Keep in mind that SARS can only provide you with a refund or lower tax bill if it knows about your RA contributions. Therefore, keep your RA tax certificate in a safe place and remember to enter the total contributions for the tax year when completing your tax return (the 2019/20 filing season opens on 1 July 2020). SARS will also ask you to submit your RA tax certificate along with the rest of your supporting tax documents.
Three weeks left of this tax year
By the second week of February every year you should have a fairly good idea of what your total income – salary, business income, interest, rental income, and bonus for the current tax year will be. If you add up all these figures, you can contribute 27.5% (capped at R350 000) of the total to your employer’s fund and your personal RA combined. If you haven’t used the full allowance yet, it’s possible to top up your RA with most administrators within a matter of days. Even if you don’t have the means to contribute the full 27.5% yet, every bit of tax relief helps.
What if you don’t have an RA?
It is possible to open an account within a few days. Discuss the options with your financial planner and make sure you understand the total costs and restrictions involved, as well as the risks attached to the underlying funds in your RA.
We offer both actively managed and index-tracking (passive) funds for your RA
The Sanlam Investment Management (SIM) Retirement Plan offers you a choice between three SIM funds with different risk levels, while the Satrix Retirement Plan has the Satrix Balanced Index Fund and Satrix Low Equity Index Fund as underlying investment choices. More information is available on sanlaminvestments.com