One of the most important aspects to consider in your long-term financial plan is how to minimise your tax liability. Paying more taxes than you have to, over a long period of time, can have seriously negative consequences for your financial health. Therefore, using the legal structures available to minimise your liability is the smart thing to do.
There are a number of ways to do this, but the simplest is using a Regulation 28 compliant retirement annuity.
A retirement annuity (RA) allows you to claim back from SARS a percentage of your contribution equal to your marginal income tax bracket. For example, if you fall into the 31% income tax bracket, then you can claim back 31% of your RA contribution. Below is a table which summarises the income tax brackets in 2018.
Thus the more you pay in tax, the more effective an RA is at reducing your tax liability. However, there are some limitations. Contributions to your RA are no longer tax deductible after you have contributed the lessor of either 27.5% of your income or R350 000 per annum. Below is a table indicating the maximum, tax-deductible amounts for each income bracket.
The simplest way to understand this table is as follows: Whatever amount you contribute to your RA (up to 27.5% of your income or R350 000) is tax deductible. Thus you can either pay the money to SARS, or pay it into your RA and keep it for yourself at retirement.
For example. If you were to earn R250 000 p.a. You would normally pay the following in tax:
R34 178 + (26% x (R250 000 – R189 880) = R49 809
Tax rebate = R13 635
Total tax due: R49 809 – 13 635 = R36 174 p.a. / R3 015 p.m.
However, should you contribute the maximum of 27.5% to your RA (27.5% x R250 000 = R68 750 p.a.), then this is deductible from your tax bill, meaning you are only taxed on:
R250 000 – R68 750 = R181 250
This brings you down from the 26% tax bracket to the 18% bracket (see Table 1).
Thus the annual tax which you are required to pay is calculated as follows:
18% x R181 250 = R32 625
Tax rebate = R13 635
Total tax due: R32 625 – R13 635 = R18 990 p.a. / R1583 p.m.
As you can see, contributing to your RA can both bring you into a lower tax bracket overall, and lower your tax liability.
However, contributing to a RA will reduce your cashflow and thus you would need to calculate what your affordability is. Using the maximum allowable RA contribution in the example above, the annual contribution of 27.5% of R250 000, broken down on a monthly basis, is calculated as follows:
R250 000 x 27.5% = R68 750
R68 750 / 12 = R5 729 per month
Taking into account the tax deductions which you receive on a monthly basis, the total amount it will cost you is:
Monthly RA contribution: R5 729
Monthly Tax Saving:
R3 015 (tax due with no RA contribution)
– R1 583 (tax due with RA contribution)
Actual monthly cost of RA in terms of cashflow: R5 729 – R1 432 = R4 297
Thus SARS is contributing 25% to your RA.
But can you afford to put 27.5% of your income away every month into an investment, which you can only access at age 55? Most people can’t. However, it is vital that you start saving for retirement as early as possible. Compound interest and consistency are key factors when it comes to having enough money available to retire on one day. Thus, being able to calculate the monthly amount which is affordable for you, is vital.
A good rule of thumb is to try to work towards the 27.5% figure. However, you should also take into account what contributions are being made on your behalf into your pension fund at work (typically in the range of 7.5%). Additionally, most pension funds also have an employee contribution, which may be in the 7.5% range as well. Meaning you could already be contributing in the double digits towards your retirement. This amount needs to be subtracted from the 27.5% total limit.
Pension fund employer contribution = 8.5%
Pension fund employee contribution = 7.5%
Total contribution = 16%
Remaining allowable deduction: 27.5% – 16% = 11.5%
The example above illustrates how most people who work for a company, which already has a pension fund in place, may be closer to their contribution limits than they think.
The bottom line of an RA is that it will influence your cashflow, but it will also offset your tax liability, meaning that SARS funds a portion of your retirement savings. Should you not utilise an RA, SARS will keep all of your tax. Finding a happy medium between affordability and maximising your tax deduction is key.
Taking the time to meet with a wealth manager is crucial in this regard, as you may need somebody who will help you calculate the contribution which is best suited to your income, career and earnings pattern. Furthermore, having somebody to help you navigate the minefield of sub-par retirement products which are available on the market is possibly more important than getting your contributions right. (For more details on poor quality retirement products, read Part 4 of this series.)
At Sharenet Wealth, we only utilise unit trust RAs, which are the best products available on the market currently. We offer a full selection of Regulation 28 compliant risk-rated funds, to suit every investor type. Furthermore, the unit trust wrapper allows you to stop, pause or change your contributions, whenever you wish and without paying a cent in penalties.
If you have a policy-style retirement annuity that you started years ago, contact Sharenet Wealth and we will gladly investigate if there is benefit in moving you over into a unit trust RA today. This move alone could provide you with significantly more money at retirement.
Contact us today for an obligation-free consultation.
In the next instalment of the series, we will cover combining a tax-free savings account with your RA to further optimise tax efficiency at retirement.
Ricki specializes in the field of wealth management with a focus on holistic financial planning. He has a keen interest in the investment fields of property, technology, precious metals and cryptocurrencies. Ricki also holds a Masters degree in Science from the University of Stellenbosch.