How Government is planning to incentivise you to take home less, but retire on more

As part of Government’s drive to get South Africans to invest more for their retirement, National Treasury is proposing to increase the portion of your retirement fund contributions that you can use to reduce your tax every year.

Niel Fourie, Public Policy Actuary at the Actuarial Society of South Africa, says Government is proposing to allow you to deduct up to 27.5% of your total remuneration from 2015 irrespective of whether you contribute to a pension, provident or retirement annuity (RA) fund. This recommendation forms part of National Treasury’s retirement reform proposals announced with the National Budget in February.

He says currently your tax-deductible contribution to a retirement fund is always calculated on your pensionable salary, which excludes your employer’s contribution to your pension or provident fund. In terms of Government’s proposal the tax-deductible portion will be calculated on your total remuneration package (also known as total cost to company) and not only on your pensionable salary, leading to a higher tax-deduction.

Fourie says by increasing the portion of your retirement fund contributions that can be used to reduce tax, Government is incentivising you to invest more for your retirement.

“For the majority of taxpayers, if you are investing at the maximum tax-deductible percentage, you will save on taxes and eventually you will be able to buy a significantly bigger pension once the proposals are introduced in 2015. You will, however, end up sacrificing a portion of your salary and go home will less money in your pocket.”

Fourie says the Actuarial Society supports and welcomes Government’s proposal to increase and standardise the tax-deductible retirement fund contributions from 2015. “The challenge remains to get people to save at the maximum tax-deductible levels. Consumers must be prepared to sacrifice a portion of their take home earnings in order to benefit fully from Government’s improved incentive.”

How the proposed changes will impact on you

Fourie points out that the changes contained in National Treasury’s retirement fund proposals are also aimed at treating all retirement funds the same. “This will greatly simplify the South African retirement saving system, because currently different rules apply to pension, provident and RA funds.”

He provides the following overview of how the proposed changes will impact on pension and provident fund members as well as RA fund members.

• Pension Funds

If you are currently contributing to a pension fund, you are allowed to deduct up to 7.5% of your pensionable salary from your taxable earnings every year to reduce the final tax amount. In addition, your employer can boost your contributions by another 20% of your pensionable salary. Therefore the total contribution that you can deduct from your annual salary to reduce tax is 27.5%.

In terms of the new proposed changes, however, the 27.5% would be based on your total “cost to company” salary and not only your pensionable salary. This means you will be able to deduct more from your taxable salary, which will result in lower taxes. You need to be aware, however, that this will also mean less money at the end of every month for day to day expenses.

Say you earn an annual “cost to company” salary of R500 000 a year and your pensionable salary is 80% of your package, which is R400 000.

As it currently stands, you would be allowed to contribute 7.5% of R400 000 (or R30 000) to your pension fund. Your employer can contribute up to 20% of R400 000 (or R80 000). Therefore, you can deduct R110 000 (R30 000 plus R80 000) from R500 000, leaving you with R390 000 and a tax bill of R82 000. You will therefore take home R308 000 in that year.

Using the same example, in terms of the new proposal, your 7.5% contribution and the 20% contribution from your employer may be based on your total “cost to company” salary of R500 000 and no longer the pensionable salary of R400 000. This would amount to contributions of R37 500 (7.5% of R500 000) and R100 000 (20% of R500 000). You could therefore deduct R137 500 from your salary of R500 000, leaving R362 500 that is taxable. You would have to pay tax of R72 000, leaving you with a take home salary of R290 500.

Fourie says in terms of the above example, if the new proposals had been implemented in the 2013/14-tax year, you would be incentivised to contribute R137 500 a year to your pension fund instead of R110 000. You would also pay tax of only R72 000 instead of R82 000, but you would take home R17 500 less a year (R308 000 in 2013 minus R290 500).

The table below summarises the current scenario and compares it to the proposed tax treatment of pension fund contributions for 2015.

• Provident Funds

Unlike pension fund members, provident fund members cannot claim the 7.5% tax deduction available to pension fund members.

As it currently stands, your employer can contribute up to 20% of R400 000 (or R80 000) to a provident fund on your behalf. Therefore, you can deduct R80 000 from R500 000, leaving you with R420 000 and a tax bill of R92 500. You will therefore take home R327 500 in that year.

Using the same example, in terms of the new proposal, an additional 7.5% contribution and the 20% contribution from your employer may be based on your total “cost to company” salary of R500 000 and no longer the pensionable salary of R400 000. This would amount to contributions of R37 500 (7.5% of R500 000) and R100 000 (20% of R500 000). You could therefore deduct R137 500 from your salary of R500 000, leaving R362 500 that is taxable. You would have to pay tax of R72 000, leaving you with a take home salary of R290 500.

Fourie says in terms of the above example, if the new proposals had been implemented in the 2013/14-tax year, you would be incentivised to contribute R137 500 a year to your pension fund instead of R80 000. You would also pay tax of only R72 000 instead of R92 500, but you would take home R37 000 less a year (R327 500 in 2013 minus R290 500).

Again, the table below summarises the current scenario and compares it to the proposed tax treatment of provident fund contributions for 2015.

• Retirement Annuities

Fourie says the proposed changes will have the biggest impact on RAs.

Currently the contributions to an RA fund that can be used to reduce your income and therefore your tax are the greater of:

• 15% of taxable non-retirement funding income or
• R3 500 less any contributions made to a pension fund or
• R1 750

If you are self-employed and you earn R500 000 a year, this is considered non-retirement funding income. So while you can currently invest only 15% of this income in an RA and deduct the contribution from your salary to reduce tax, it is proposed that from 2015 you can contribute up to 27.5% of your income and deduct this from your salary.

Under current rules, if you contribute 15% of your income this would amount to a RA investment of R75 000 a year. If you deduct this from your R500 000 income, you are left with R425 000, which is taxable. Assuming no other deductions apply, the tax amount would be R94 000. You would be left with R331 000.

Once the proposals have been implemented, you will be able to contribute 27.5% of R500 000 or R137 500. Once you have deducted this from your salary, you are left with R362 500 that is taxable. You would have to pay tax of R72 000, leaving you with a take home salary of R290 500.

Again, while you would be bolstering your retirement savings by R62 500 and benefit from reduced tax of R22 000, your take home pay would be R40 500 less under the proposed new system.

Fourie estimates that if you are a self-employed person saving at the maximum tax-deductible percentages, you will be able to buy roughly an 80% bigger pension at retirement as a result of the proposed increased tax-deductions than you would if you continued saving at the current percentage.

Who will not benefit?

Fourie says everyone earning up to R1.3 million a year will benefit from the proposals. National Treasury is proposing to cap tax-deductible contributions at R350 000 a year from 2015, which will reduce tax deductible contributions for those earning more than R1.3 million a year. Currently no cap applies.