Limits on tax deductibility don’t mean a limit on retirement contributions
Contributions to pension, provident and retirement annuity funds are tax deductible but limited to 27.5% of the greater of remuneration or taxable income, up to a maximum of R350 000 per year.
This doesn’t mean, however, that your contributions per se are limited to R350 000; only the amount that is deductible in any tax year is limited. This means you can contribute more than R350 000 in any tax year, and still enjoy potential tax benefits in the future.
By contributing to retirement funds, you can reduce your tax payable to SARS and grow your retirement nest egg at the same time. Coupled with the fact that there are no taxes payable on the growth in investments within a retirement fund, this makes it the best vehicle for retirement savings for most investors.
Section 11(F) of the Income Tax Act 58 of 1962 (the Act) states that contributions made to retirement funds which did not previously qualify for deduction can be:
carried forward to the following tax year
offset against any lump sums taken
exempted from compulsory annuity income under section 10C of the Act.
Carried forward to the following tax year
This means that if for example, you’ve contributed R500 000 to your retirement fund in the current tax year and R350 000 was deducted in the following tax year the balance of the R150 000 can be carried forward as a deduction in that year.
Offset against any lump sums taken
Let’s take the same example of a contribution of R500 000 made to a retirement fund, but assume that the R150 000 remains unclaimed. Say you retire from your retirement fund with R9 million in capital. You can commute up to one-third (i.e. R3 million) as a lump sum and then use the remaining R6 million to purchase an annuity.
Since the excess contribution of R150 000 wasn’t deducted previously, this can be offset against your R3 million lump sum, thus reducing the amount of tax you pay on your lump sum withdrawal. You will thus pay tax on R2 850 000 as opposed to on the full R3 million (R3 000 0000 - R150 000 = R2 850 000).
Applying the current retirement fund lump sum tables and assuming you haven’t received any previous lump sums (i.e. you still have R500 000 that is tax free), you’ll pay R778 500 in, and receive an after-tax amount of R2 221 500. If you didn’t have the excess contributions available, you’d have paid tax of R832 500 and only received a lump sum of R2 167 500.
Exempted from compulsory annuity income under section 10C of the Act
Using the same example of a retirement fund value of R9 million and assuming you didn’t take a lump sum at retirement and used the full amount to purchase an annuity, your yearly annuity will be exempt to the value of R150 000 until it’s exhausted. Practically, if you draw an income of R225 000, R150 000 of that income will be exempt from tax in that year.
It’s also worth noting that should you pass away your retirement funds are exempt from estate duty. Post retirement, the value of your living annuity will also be exempt from estate duty. However, contributions that didn’t qualify for deduction will be included as property in the estate and may be subject to estate duty in terms of section 3(2)(bA) of the Estate Duty Act (Act 45 of 1955). In our example, the R150 000 that didn’t previously qualify for deduction will be included as property and may be subject to estate duty.
Contributing beyond the limits can help those if you started saving for retirement late and need to catch up. It’s important to consult your financial adviser, especially if you’ll be retiring soon, to ensure that your retirement savings are optimised to meet your long-term goals.