While there are very few tax breaks for individuals, some huge ones are available for retirement funding
STEVEN JONES
RETIREMENT TAX breaks in South Af-rica are designed to incentivise individu-als to save for retirement and provide them with tax relief on contributions to retirement funds. The government has implemented various tax incentives over the years to encourage individuals to save for their retirement and reduce their reliance on the state in retirement. The tax breaks on offer benefit your contributions, the build-up of your fund, and (to a certain extent) when you draw them down.
Tax exemption helps retirement funds to grow at a faster rate, increasing the eventual retirement benefits that individuals will receive.
Contribution phase
One of the main retirement tax breaks in South Africa is the tax-deductibility of contributions made to retirement funds. Individuals can claim a tax deduction on contributions to pension, provident, and retirement annuity funds, up to a certain limit. For the 2023/24 tax years, the tax-deductible contribution limit is 27.5% of their taxable income or remuneration or R350 000 per annum, which-ever is higher.
However, this does not limit the total amount that you can contribute to your fund. For workplace retirement funds (pension or provident funds), your contributions may be limited by the rules of the particular fund, but for private retirement funds (retirement annuities), there is no upper limit.
All is not lost on the tax front, either. Any contributions that you make that are disallowed as a tax deduction du- ring one particular tax year are carried over to the following tax year. If the following year’s contributions are below the allowable limits for that year, SARS will allow a deduction of the amounts previously disallowed up to the current year’s limit. When you get to retirement, if there’s still a portion of your cumulative contributions that had not been allowed as a deduction over the years, this disallowed portion will be added to the amount allowable as the tax-free com-ponent of your lump sum.
Build-up phase
In addition to the tax-deductibility of contributions, retirement funds are also tax-exempt during the accumulation phase. This means that the investment returns earned by the fund are not subject to tax. This tax exemption helps retirement funds to grow at a faster rate, increasing the eventual retirement benefits that individuals will receive.
To understand the power that a retirement fund’s tax-exempt status gives to your investment returns, compare this to what happens to your investment portfolio that is not housed within a tax-exempt ‘wrapper’.
Take a share portfolio, for instance. While most investors would consider shares to be a longer-term investment, very few (if any) would be like one of my former clients who would buy (say) 1 000 shares in Anglo-American, put the share certificate* in a safety deposit box, and leave it there for the next 40 years!
On the contrary, any astute investor would be constantly monitoring their portfolio, selling specific shares and adding other shares when appropriate. This ongoing process of ensuring that the components of the portfolio continue to meet the investment objectives is called ‘rebalancing’. Unfortunately, every time the investor sells a share in their portfolio, a potential Capital Gains Tax (CGT) liability is triggered—even if the proceeds of the sale are reinvested.
Such an investor would have less to re-invest, since some of the proceeds would need to be held back to cover the CGT liability. If the full proceeds are reinvest-ed, other shares would need to be sold when the CGT needs to be paid over to SARS—which in turn triggers its own CGT liability, and the cycle continues…
This is not the case with an investment portfolio housed within a retirement fund wrapper. In this case, the fund—being a tax-exempt entity—pays no CGT on sales, Dividends Withholding Tax on dividends, or income tax on interest and rent. Less money for SARS therefore means more money for you to reinvest!
* The fact that share transactions have been managed electronically since 1999 gives an indication of how long ago this was!
Preservation phase
When an individual leaves their employ-er, they can choose to transfer their retirement fund to their new employer or to a preservation fund. Transfers to preservation funds are tax-free, and like with any other retirement fund in the build-up phase, the investment returns earned by the preservation fund are also tax-exempt.
The difference between a preservation fund and any other retirement fund is that you would not be able to make additional contributions to a preservation fund—it is designed to preserve existing fund benefits.
You are entitled to make one withdrawal from a preservation fund before retirement, but this withdrawal will be taxed at the lump sum withdrawal rates (above, top) rather than the more generous lump sum retirement rates (above, bottom).
Employees who retire from their employer may be in a situation where they don’t need to access their retirement funds immediately—-perhaps due to having other sources of savings or in-come, or taking up other employment. This gives rise to the question: Is one forced to retire from the fund at the same time as they retire from their employment?
The answer depends on the rules of the fund or their contractual conditions of employment, as there’s no legislative prohibition on transferring their employer retirement fund to another retirement fund—whether this is their new employer’s fund, a retirement annuity fund, or a preservation fund.
If such a prohibition does exist, many employees contemplates resigning from their employers in order to facilitate such a transfer, rather than retiring. However, it is important to carefully consider the possible loss of post-retirement benefits (e.g. employer-subsidised medical fund membership) before making one’s decision.
Drawdown phase
When an individual retires and starts receiving benefits from their retirement fund, these benefits are subject to in-come tax. However, the government has provided additional tax breaks to retirees to reduce their tax liability.
