Practice Notes
Disallowed retirement fund contributions – do not undervalue AT and IN retirement tax benefits
Key Points
- Before retirement – the discipline and patience to save more than your annual limits pays off at retirement.
- At retirement – disallowed contributions will reduce your tax payable on retirement lump sums greater than R550 000.
- In retirement – whatever portion of your disallowed contribution ‘pool’ is still available will result in a SARS tax refund on your annuity income until depleted.
Not many individuals are aware of the fact that any retirement contributions that did not qualify for an income tax deduction pre-retirement – in other words, disallowed contributions – can be used to reduce tax payable on (1) retirement lump sums and (2) annuity income in retirement.
In this article, we briefly discuss and provide examples to demonstrate how disallowed contributions can reduce the tax payable AT and IN retirement.
Before retirement
During your working career retirement contributions to a retirement fund are tax deductible. This could consist of a combination of a retirement annuity and a pension/provident fund with your employer. These contributions can be deducted from your taxable income up to a maximum of 27.5% of the higher of your remuneration or taxable income, capped at R350 000 p.a. If your contributions exceed these limits, you start building up a ‘pool’ of contributions referred to as disallowed contributions.
This does not mean, however, that your contributions per se are limited to R350 000, rather it means that the deductible amount in any tax year is limited. Thus, higher income earners can contribute more than R350 000 in any tax year and still enjoy potential tax benefits AT and/or IN retirement.
At retirement
If you opted to take a cash portion at retirement, it is capped at one-third of your retirement savings value. The balance must be used to purchase a compulsory annuity – living annuity or life annuity. The first R550 000 withdrawn is tax-free, assuming you have not taken any cash portion from other retirement funds previously. The remaining lump sum will be taxed according to the retirement tax tables.
The individual’s disallowed contributions accumulate and when he/she retires, the disallowed contributions can be used to reduce the gross lump sum figure on which the tax will be calculated.
In retirement
Once retired, the portion of your retirement savings that was not taken as a cash lump sum is used to purchase a life or living annuity. The income you earn from this investment is taxed as per the income tax scale.
It is here that the benefit of Section 10C of the Income Tax Act becomes applicable. Whatever portion# of your disallowed contribution ‘pool’ that is still available can be offset against this income. The individual pays less/or no tax until the previously disallowed contribution has been fully utilised.
It is never too late to save
It is never too late to save and contributing beyond the annual limits could help those that started saving for retirement late and/or not enough and need to catch up. Hence, it is important to consult your financial adviser, especially if you will be retiring soon, to ensure that your retirement savings are optimised to meet your goals at retirement.
Making additional contributions towards retirement savings remains a no-brainer. Patience is required, as disallowed contributions will save the individual tax on the day of retirement.
INN8 Invest is not a tax professional. Please seek the appropriate assistance /advice from a qualified financial or tax adviser.
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