Retirement and tax – what you need to know: Part 1


Tax laws are constantly changing, and these changes can affect your retirement savings. While you need to consider the impact of tax when planning your retirement savings strategy, it shouldn’t be your primary concern. Here’s Part 1 of a handy guide.

Tax is certain, and there's no avoiding it. That said, it needs to be factored in both while saving for retirement, and during retirement, given the different tax treatment of those two scenarios.

Broadly speaking, the taxation process can be summed up as "exempt-exempt-tax", consistent with regulations in many countries globally. You are exempt from tax on contributions made while saving for retirement (up to certain limits), and you are exempt from gains on the investments while you are saving, but you are subject to income tax upon retirement as you draw down your savings.

Retirement savings vehicles

The key retirement savings vehicles are retirement annuities and pension or provident funds. The main difference between these products is that the latter are employer-provided and are typically mandated in most large businesses. Retirement annuities are typically used by self-employed individuals, employees in organisations that don’t offer a pension or provident fund, and those who want to increase their retirement savings.

The main benefits of retirement annuities are that you are able to contribute to as many of them as you wish, you can stop contributing whenever you want, and they are transferable. There is additional flexibility in that lump-sum retirement annuities are available. This is a tax-efficient way to house any excess savings, as you are able to use the lump-sum amount to reduce your income tax liability in that year.

The new Taxation Laws Amendment Act

The signing into law of the Taxation Laws Amendment Act (2015) and Tax Administration Laws Amendment Act (2015) by former President Jacob Zuma, which came into effect on 1 March this year, has prompted many questions from those who are saving for retirement through retirement annuities, pensions and provident funds.

In short, the Act ensures that the tax benefits of contributions to provident funds, pension funds and retirement annuities are now on an equal footing. (See our Q&A for more details on how the new Act will affect you.)

It is also important to note that most people currently saving for retirement will be unaffected or better off under the changes. High-income earners are likely to be the most affected by the changes.

How the Act affects you: before retirement

The tax deduction increases from 15% to 27.5% of income, up to a maximum of R350 000 annually, on contributions made towards structured retirement savings, and now applies across the board, in other words, to provident funds, pension funds and retirement annuities.

The distinction between retirement funding and non-retirement funding income has also been removed. That means all clients who were members of a pension or provident fund, and can now top-up their retirement savings to the limit of 27.5% by taking out a retirement annuity.

And with effect from 1 March, only employees are able to claim contributions, regardless of whether they actually made them (companies will often contribute to an employee’s pension).

How the Act affects you: after retirement

The new laws mean that the rules governing provident funds will, in effect, change to the same as those governing pension funds.

Provident fund members will now only be able to withdraw one-third of their savings at retirement, and they will be required to purchase an annuity with the remaining two-thirds. Effectively, one could argue that the government is looking to help protect retirees by enforcing compulsory preservation and making it impossible for hard-earned savings to be withdrawn in a lump sum.

To learn the following:

  • The current tax rates for lump sum withdrawals
  • Important exceptions to annuity rules
  • How your annuity is taxed
  • Whether early withdrawals are still possible
  • More about tax-free savings accounts     
Read part 2 of this handy guide to retirement and tax.

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