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Maximise your retirement savings to soften the tax budget burden

12 March 2019 Momentum Corporate

If you’re a South African concerned about how far your rands will get you in life – chances are you’ve probably got up to speed on the recent National Budget Speech. While it was expected that Minister Tito Mboweni would keep personal income tax rates for South African income earners unchanged, the announcement regarding personal income tax brackets not being adjusted for inflation, caught many by surprise.

Regard Budler, Head of Product Solutions at Momentum Corporate says that even though the tax rate and brackets remain unchanged, regular inflationary increase in salaries will bump many South Africans into a new tax bracket, impacting their take-home pay. “The increased tax liability is commonly referred to as ‘bracket creep’, this means any salary increase you may get will likely be offset by having to pay the higher tax rate in the new bracket. This ‘stealth tax’ will see employees paying more of their income to the government in real terms without people really feeling this on their pockets.”

One way to reduce the impact of this increased tax burden on your pocket is to take full advantage of the tax breaks created by the State to encourage South Africans to save and invest towards their retirement. Budler says that maximizing your contributions or making a lump sum payment towards your pension, provident or retirement annuity is the most efficient way to minimise the impact of rising taxes while building long term capital.

“Not only will you soften the blow to your net worth, but the additional savings will benefit from the power of compound interest. This means even a small savings amount will blossom into a much greater sum over time, helping you reach financial security in your old age and not become an economic burden on your children or the state,” adds Budler.

He explains that employees currently earning a single source of income, such as a salary from a sole employer, are eligible to deduct any contribution towards their formal retirement savings up until the value of 27.5% of their total remuneration, or R350 000 before tax deductions and taxable capital gain – whichever is lesser.

“This means that the contributions are deducted from your income before calculating the tax due, as long as the contributions fall within the prescribed limits,” adds Budler.

To illustrate the point, Budler says that for high-income earners in the highest tax bracket, for every R1 000 contributed to their retirement fund they could reduce their tax bill by as much as 45%, or R450 per month. Most people could expect to save around R200 for each R1 000 contributed to their retirement savings per month.

Alternatively, Budler says that members could consider making a lump sum contribution towards their retirement fund. “If you are a member of an umbrella fund, there is a good chance that you will also be able to make additional voluntary contributions, as most umbrella funds offer this flexibility. These once-off contributions to the retirement fund offer the same tax saving benefit as regular contributions.”

But, Budler concedes that tax can be tricky at the best of times and suggests that if an employee is unsure, they should speak to their employer or financial adviser about increasing their retirement contribution to reduce the impact of the recent real tax hike.

What we can also learn from the bracket creep principle is that another effective way to increase your contributions towards retirement it to make these increases at salary review date. For example, if you receive an annual inflationary adjustment to your salary of 6% and decide to increase your contribution rate towards retirement by 1%, your take home pay would roughly increase by 5% but in only a 5 years you have increased your contributions by 5% making a material difference to your retirement position without feeling the impact on your pocket directly.

“No one relishes handing more hard-earned money to the tax man. However, tax-wise choices such as making the most of the deductibility of your retirement fund contribution and making additional voluntary contributions to your retirement fund will soften the blow while improving the savings culture in South Africa,” concludes Budler.

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