Taking a closer look at why taxpayers may be required to pay in tax on pensions or annuities on assessment and how they can avoid a repetition of this each year.

Why do I have to pay in if I earn a small pension annuity?

During the tax filing season, many tax practitioners will receive numerous queries as to why pensioners and those who have retired are now suddenly required to pay money into SARS. Retired taxpayers who are settling into their retirement no longer receive monthly payslips which show PAYE deductions. When, as is increasingly happening, they are asked to settle an amount with SARS every year it is usually an unexpected financial shock. Pensioners who find themselves in this situation are often forced to pay over money they thought belonged to them and they are at a loss as to why this happens.

Before we go on to explain why this occurs, let’s just take one step back to clarify how this pension annuity income arises in the first place. Taxpayers can save for retirement by contributing to a pension, provident or retirement annuity fund (or even a combination of these). These taxpayers will enjoy a tax benefit whereby their contributions will qualify for a tax deduction of up to 27.5% of the greater of their taxable income or remuneration (limited to R350 000 per year).

On retirement, those taxpayers who contributed to a pension fund or retirement annuity fund may withdraw up to one-third of their savings as a lump sum and must use the remaining two-thirds to buy a monthly pension or annuity (provident-fund members can withdraw their entire benefit as a lump sum). The exception is that when the total value of the fund is R247 500 or less, the taxpayer can withdraw the balance in full and is not obliged to purchase the annuity.

It is this monthly pension or annuity that the taxpayer receives on retirement that we will explore in more detail below.  

Pensioners often receive several annuities, pensions or some other form of monthly income from their previous employer or a fund each month. In most instances, each amount received (when looked at individually) falls below the tax threshold, especially if the taxpayer is older than 65 years. However, when all the amounts are added together, taxpayers actually find themselves having earned more than the tax-free threshold and therefore tax is owed to SARS. Such taxpayers then find themselves having to suddenly pay SARS on assessment. And, many of these taxpayers, relying on their monthly income, do not have the money to pay the tax owed and thus find themselves in financial trouble.

Example of multiple annuities resulting in tax owed (tax year 2020)

Taxpayer A is 67 years of age and receives three different IRP5s or IT3(a)s from the following sources based on her monthly income:

Retirement Annuity Fund (RAF) = R5 000 per month

Pension Fund = R3 000 per month

Living Annuity = R4 000 per month

Total Income = R12 000 per month

Annual Income = R144 000

The tax threshold for Taxpayer A is R122 300, given her age. However, on each individual IRP5 or IT3(a), the annual amount received is less than R122 300. See below:

Annual RAF = R60 000

Annual Pension Fund = R36 000

Annual Living Annuity = R48 000

Therefore, the entity behind each of these funds would not have withheld any tax to pay it over to SARS.  This is because each fund would not have been aware that the taxpayer also receives other amounts and would have assumed that the annuity it pays is the only income received. However, when all the amounts received are added together, the taxpayer actually earned R144 000 throughout the financial year. This is greater than the tax-free threshold for a 67-year-old taxpayer, i.e., R122 300.

Thus, for the tax year ended 2020, using the tax tables, R3 906 tax should be paid on the total annual income.

As a result, when Taxpayer A files her tax return for the tax year ended 29 February 2020, she is required to pay tax of R3 906. At this stage, she is unsure as to why this is the case as none of the funds withheld any tax.

Takeaway

Taxpayers must always be aware that if they receive income from multiple funds or entities, they would need to add up all the income received to determine whether any tax would be owed to SARS.

Below are three methods which can be used to avoid facing a nasty tax bill at the end of the financial year:

1. Advise one or more of the funds that you receive other income and ask them to withhold a portion for tax before making the monthly payment.
2. Calculate how much tax would be owed on the total amount received and put away a monthly amount yourself in the bank so that you can easily pay SARS when the amount is due. If you choose this option, you will benefit from the interest that the money you set aside will accumulate before you have to make the payment ot SARS.
3. Register as a provisional taxpayer and settle an amount with SARS every six months based on the eventual tax owed.

By following any of the above methods, taxpayers will not be caught off guard and will be able to pay the taxes owed to SARS without any hassle.