Stay abreast of taxation changes

Part of the long-term financial planning process is to structure your client’s portfolio as tax efficiently as possible. A thorough knowledge of the retirement annuity and savings legislative environments is crucial to secure maximum benefit at both contr

South Africa’s tax and savings environment is tweaked each year when National Treasury presents its annual National Budget. It is essential that you revisit your client’s financial plan – at least once annually – to make sure it accommodates changes to tax thresholds and various savings-linked deductions.

Mild improvements

Over the past decade South Africa’s Finance Ministers have carved out a slightly better ‘deal’ for individual taxpayers. Among the improvements are the gradual relaxation of tax thresholds (the level of income at which your client begins paying tax) and increases in the interest free abatement.

In the 2011/12 Budget, tax thresholds for individuals were set as follows: Under 65 years of age (R59 750), over 65 years (R93 150) and over 75 years (R104 261). Individuals under 65 years can also receive R22 800 in interest “tax free”, while those 65 and older qualify for R33 000!

Understanding “tax free” income

If we narrow our discussion to individuals of retirement age, then we can calculate the “tax free” income (at today’s values) of R116 980 per annum. What does this mean?

Matthew Lester, Professor of Taxation Studies at Rhodes University, Grahamstown, presented some interesting analysis in a recent paper titled Retirement Benefits from Retirement Funds. He says, given inflation at 6% and growth of 14% per annum, the total capital requirement to achieve tax threshold on retirement (at age 60) would be R1 155 000.

At withdrawal

What happens when you withdraw from a retirement fund? Your client can take up to one third of the capital accumulated in the fund, with the balance set aside to purchase an annuity to provide income through retirement. To decide the best attack, one must consider the exemption on taxation of retirement fund lump benefits upon retirement or death. The existing R300 000 exemption was increased to R315 000 with effect from 1 March 2011.

Unfortunately the taxes levied on lump sum withdrawal escalate rather quickly. You pay 18% on amounts between R315 000 and R630 000, for amounts between R630 000 and R945 000 you pay R56 000 plus 27% of the amount exceeding R630 000, and you pay R141 750 plus 36% of any amount exceeding R945 000. Prof. Lester reckons there is some sense in withdrawing up to R630 000, thereby paying an average tax rate of just 9%: “But above R630 000, most would consider that the funds would be better off remaining in the fund until withdrawal by way of annuity payment.”

Taxation on contributions

Now that we’ve considered your approach at retirement, it is worth looking at changes in the “saving for retirement” environment. Your client currently claims income tax deductions for contributions to pension and retirement annuity funds. Any employer contributions to retirement funds on behalf of employees are also not taxed in the hands of employees. But this will change from 1 March 2012.

Treasury is pushing ahead with its objective of achieving greater equity in taxation structures by ruling that an employer’s contribution on behalf of an employee be deemed a taxable fringe benefit in the hands of the employee! Each individual taxpayer will be allowed to deduct up to 22.5% of their taxable income for contributions to pension, provident and retirement annuity funds, but with limits. A minimum annual deduction of R12 000 and an annual maximum of R200 000 apply! Clients earning a gross salary exceeding R889 000 per annum will be slightly worse off – in terms of retirement funding benefits – from the next tax year.