You have 16 days left to take advantage of Finance Minister Trevor Manuel's "special offer" to reduce your taxes for the year - while at the same time improving the likelihood of retiring financially secure.
February 28 is the deadline for the second payment of provisional tax. It is also the cut-off date if you want to reduce your tax liability for the year. In both cases, you have to do your tax sums before the end of the tax year, which is February 28.
The tax laws allow you to deduct limited amounts from your taxable income to fund your retirement. It is not that you do not pay tax on these deductions. You do - but only when you draw the money as a pension when you are in retirement. But then you will get a favourable rate of tax on any lump sum you are entitled to take from your retirement savings. And don't forget that you pay less tax if you are 65 or older.
By saving in a retirement savings vehicle, you are effectively deferring the payment of tax until you retire. The money you don't pay in tax is also earning investment returns until you withdraw it as a pension. So you get a double advantage.
The main ways to save for retirement and take advantage of tax incentives are through:
- Employer-sponsored pension funds. This includes both defined contribution and defined benefit pension funds, but excludes provident funds.
- Umbrella funds. There are open umbrella funds and restricted membership umbrella funds.
* Open umbrella funds. These funds are mainly administered by life assurance companies. Effectively your employer signs up on your behalf and on behalf of other employees. Your employer becomes a participating member and passes on both your contributions and any contribution the employer may make to the fund.
* Restricted umbrella funds. Membership of a restricted umbrella fund is normally limited to members of an industry group or a trade union.
- Retirement annuities (RA). These are in effect life assurance endowment policies that have tax advantages.
If you are a member of an employer-sponsored and/or umbrella fund, you may deduct from your taxable income your contributions to the fund, up to a maximum of 7.5 percent of your taxable pensionable income. Pensionable income excludes such things as motor vehicle allowances.
If you are saving money in an RA, you may deduct from your taxable income the contributions you make to that RA, up to a maximum of 15 percent of your non-retirement funding income. (Taxable income is income that is subject to tax after the deduction of any exemptions from your taxable gross income).
RAs can be used by people who are or who are not members of pension or umbrella funds.
You should sit down at the beginning of each year (with a financial adviser if you are not sure of how all this works) and calculate the maximum that you can contribute to retirement savings vehicles to take full advantage of how much you can contribute on a monthly basis.
Very few people who are members of employer-sponsored pension funds or umbrella pension funds actually contribute the full 7.5 percent. However, most funds permit you to make additional voluntary contributions on a monthly basis. If you can afford it, you should always make the maximum contribution before deciding to use RAs, because this is likely, by far, to be the most cost-efficient way to save any additional money because pension funds tend to have lower costs.
Obviously, however, many people cannot predict how much they may earn in a year. For this reason, you are allowed to top-up any contributions to the maximum tax-deductible limit with lump sums.
The best time to calculate any top-up is in February, the last month of the tax year, when you have a far better idea of your income and how much you can contribute.
Very few retirement funds allow you to inject an additional lump sum amount of cash into the fund in the last days of February. However, you can take out an RA or add money to an existing RA.
Effectively, if you are paying the top marginal tax rate of 40 percent, and you contribute 15 percent of your non-retirement funding income to an RA and claim it as a deduction, Trevor Manuel will be adding 40 percent of the amount you contribute to your retirement savings, rather than claiming it from you as tax.
This is a good deal, but time is running out if you want to take advantage of Manuel's "special offer".
How you can take advantage of Mr Manuel's offer
Example 1
The following example illustrates (a) the tax you will pay if you are contributing six percent of your pensionable income to a retirement fund and (b) what that contribution saves you in tax.
Annual salary (pensionable income)R100 000
Car allowance (non-pensionable income)+ R40 000
Rental income from investment property (non-pensionable income)+ R80 000
Total income= R220 000
Less retirement contributions of
six percent of pensionable income (six percent of R100 000)- R6 000
Gross taxable income (R220 000 - R6 000)= R214 000
*Taxed at a marginal rate of 38 percentR56 790
Less primary rebate- R5 800
Tax payable= R50 990
Tax savings from retirement fund contributionR2 280
Example 2
This example shows how increasing your retirement fund contributions to 7.5 percent of your pensionable income will (a) decrease the amount of tax you pay and (b) increase your savings.
Annual salary (pensionable income)R100 000
Car allowance (non-pensionable income)+ R40 000
Rental income from investment property (non-pensionable income)+ R80 000
Total income= R220 000
Less retirement contributions of
7.5 percent of pensionable income (7.5 percent of R100 000)- R7 500
Gross taxable income (R220 000 - R7 500)= R212 500
*Taxed at a marginal rate of 38 percentR56 220
Less primary rebate- R5 800
Tax payable= R50 420
Tax savings from retirement fund contributionR2 850
Example 3
You will pay even less tax by increasing your retirement fund contributions to 7.5 percent of your pensionable income and contributing 15 percent of your non-pensionable income to a retirement annuity (RA).
Annual salary (pensionable income)R100 000
Car allowance (non-pensionable income)+ R40 000
Rental income from investment property (non-pensionable income)+ R80 000
Total income= R220 000
Less retirement contributions of
7.5 percent of pensionable income (7.5 percent of R100 000)- R7 500
RA contribution (15 percent of rental income, which is R80 000) R12 000
Gross taxable income= R200 500
*Taxed at a marginal rate of 38 percent R51 660
Less rebate- R5 800
Tax payable = R45 860
Tax savings from retirement fund contribution: R7 410
*Calculations are based on the 2004/5 tax tables.
Retirement annuities to consider
If you are in the market for a retirement annuity (RA), consider these options which have lower costs and no confiscatory penalties if you have to reduce your premiums at a later stage:
- Old Mutual's unit trust RA. Rob Rusconi, the independent actuary who blew the whistle on the high cost of retirement savings last year, uses this product to save for his retirement. Although Old Mutual sales agents do not seem to actively market the product, it is also extensively used by Old Mutual employees.
- Old Mutual's new Max range of products, which includes options for as-and-when commission and no penalties for changing premiums.
- The Allan Gray unit trust RA. You don't pay commission if you buy the product directly from Allan Gray.
- Sanlam's new pay-commission-as-you-go RA, which is part of its Stratus range of products.
- The Momentum Life RA, which is part of its new Investo Four range of products, which includes options for as-and-when commissions and lower penalties for flexible premiums.
- Top-performing unit trust management company Coronation is working on a low-cost RA without surrender penalties, which it hopes to bring on to the market soon.
Old Mutual, while still not directly answering Personal Finance's questions about why its unit trust RA is not more actively marketed by its agents, says it is concerned about the issue of surrender penalties on recurring premium contracts, particularly older products and RAs.
Paul Hanratty, the deputy managing director of Old Mutual, says: "I believe this to be one of the most important and pressing issues faced by our industry. We are considering certain changes to improve the situation where clients change their circumstances."
Remember:
Commissions can be negotiated, and the lower the commission, the more of your premium is invested.
Health warnings
- Be aware of the cost structure of a retirement annuity (RA). All RAs are sold under a life assurance licence. However, increasingly, many companies, particularly unit trust companies and linked investment companies, are selling RA products that have lower costs than those marketed by traditional life companies. You need to compare costs on a reduction-in-yield basis. The best way to do this is for your financial adviser to calculate how much you will pay in total in premiums and then calculate the effect that the costs will have on this amount over the contract period.
- Beware of any early surrender penalties. With many traditional RAs, you are penalised if you reduce or stop paying the contributions. There are RA products that allow you to alter premiums at your discretion without you being penalised.
- Take out an RA as early in your working life as possible, because the longer you have it, the greater the tax advantages, both in the build up to retirement and at retirement.
- An RA must only be used as a vehicle for retirement savings. You cannot draw money from an RA before the age of 55 (the earliest retirement age recognised by the South African Revenue Service). At retirement, you will have to use a minimum of two-thirds of the RA to buy a monthly pension.
- Never take out an RA that matures after you turn 55, unless you are over the age of 50 - and then limit the term to five years. The policy can be extended without incurring a penalty up until the age of 69, at which age you are obliged to mature your retirement savings.
- RAs offer a range of underlying investment options. However, be very wary of costs involved in wide choice.