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Tax & Retirement- What you need to know

Posted under Guides

What’s the difference between a Pension, Provident and Retirement Annuity Fund?

The big distinction between the three is that you can only join a Pension or Provident Fund when you work for a company. So, if you’re saving for retirement by deducting amounts off your salary each month, it’s most likely that you’re contributing to your company’s Pension or Provident fund.

A Retirement Annuity (RA) is different because it is independent of the company employing you. If you run your own business and operate as a sole proprietor, then this is the way you will probably be saving for retirement. You can however contribute to a RA via your employer and in fact, many companies are now switching to RAs, because they offer more flexibility and choice for their employees. 

The main difference between these funds is how they’re treated when you retire, or when you want to take the money out. When a member of a pension or provident fund retires, they can choose to withdraw up to one third of the total benefit as a cash lump sum, while the other two-thirds must be paid out as a pension over the rest of their life. A provident fund member can however choose to withdraw the full amount at retirement if they want to.

There is an exception to the above which applies across all three types of funds – if the entire value of the fund is less than R247 500, then you can withdraw the entire fund value as a lumpsum.

The other difference is that a member can withdraw from a Pension or Provident Fund at any stage before they retire, however members of an RA can’t cash out before reaching 55 years old, except if they’re formally emigrating from South Africa or the amount is less than R7000.

Here is a summary of the differences between the three:


How does tax on retirement work?

If you’re diligently putting money away for your retirement in the form of a pension, provident fund or retirement annuity, you’re probably familiar with the retirement fund tax laws, which came into effect on 1 March 2016.


If you’re a little sketchy on the details, here's a quick recap:

Before March 2016, the different types of retirement funds (pension funds, provident funds and retirement annuities) each had their own set of tax deductions and limitations. Which was rather confusing! However, from 1 March 2016, under the new regulations, all types of retirements funds are treated the same for tax purposes. Essentially what National Treasury is trying to do, is to encourage us all to save more and preserve our funds for longer, well into our golden years. Let’s go over all the details.


The retirement fund tax deduction

Before 1 March 2016, if you contributed to a provident fund there were no tax benefits, while pension funds and retirement annuities each had their own set of complicated deductions and limits.

As of 1 March 2016 though, this has changed. It doesn’t matter whether you have a pension, provident or retirement annuity (RA) fund – or even a combination of all three – you’ll qualify for a tax deduction of up to 27.5% of your taxable income (up to a maximum of R350 000 per year). This limit applies to the total contributions you made into all funds for the whole year.

In the case of a contribution to a Pension or Provident via your employer, the sum of your employee AND employer contributions count towards this deduction. This means you'll save a significant amount on your annual tax bill – which is a great reason to start saving for your retirement now, if you haven’t already.

Example

Let’s say your taxable income (which includes salary, rental income, freelance income etc) is R20 000 per month and you contribute R1000 to an RA and R600 to a provident fund each month.

This means your total retirement contributions for the year are:

(R1000 x 12) + (R600 x 12) 
= R12 000 + R7200
= R19 200 

Your annual taxable income, before deductions, is R240 000 (R20 000 x 12 months). 


This means that you can claim a tax deduction of up to R66 000 (27.5% of R240 000). You’re limited to the total of your actual contributions though, so in this case the amount of R19 200 can be deducted from your taxable income for the year.

Taxable income = R240 000
Retirement fund deduction allowed = R19 200 
R240 000 – R19 200 = R220 800

So, your ‘new’ annual taxable income (after deductions) is R220 800. This will be the amount used to calculate your tax and not R240 000.

 

Under the old laws (before 1 March 2016), the only amount allowed to be deducted would’ve been the RA contribution of R12 000. Under the new rules, you’re getting an additional R7 200 in tax deductions.

If you contribute above the 27.5% limit (and less than the R350 000 cap) the excess contributions will be carried over and deducted in the next year. If, at retirement, you still have carried forward contributions, then your excess contributions can be used to decrease the tax you may need to pay on any cash lump sum you take out, or to reduce the taxable portion of your living annuity income in retirement. 

It’s always best to keep a record of all the retirement contributions you make across all the different funds you contribute to each month, so you know exactly where you stand.

The taxation of your employer’s contribution

Many employers structure salaries in such a way that they make contributions on your behalf to a pension, provident or RA Fund automatically each month. These contributions will be included on your IRP5 as part of your income, and then taxed as a fringe benefit every month (you will see it listed on your payslips).

However, what’s important to note is that these employer contributions will be deemed to have been made by the employee (that’s you), and are therefore also included when SARS works out the total retirement deduction you can claim (as explained above). What this means is that even if your employer “pays” for it and you get taxed as part of your salary, SARS will allow you to deduct it as well.




Benefits of the March 2016 retirement fund tax amendments

We like the latest amendments to the retirement fund tax legislation. Here’s why:

  • It simplifies the tax treatment of retirement funds by treating them all the same way for tax purposes. The different treatment under the old tax laws was very confusing!
  • It provides a great opportunity for individuals to increase contributions to their retirement funds and obtain a bigger tax saving in the process.
  • Employees contributing to a provident fund can now also enjoy a tax saving each month and therefore potentially see an increase in take-home pay!



Where do I claim for retirement on my tax return?

If you contribute to a Pension or Provident Fund via your employer, these contributions will be reflected on your IRP5. Your employer’s contribution will be reflected on the income side and taxed as a fringe benefit, while your total contributions (i.e employer plus employee) will be shown on the deductions side. Your pension and provident fund details will therefore be pulled into your tax return via your IRP5, so you mustn’t capture these details again anywhere separately.

However, if you contribute to a Retirement Annuity personally or via your employer, you need to complete the separate section on your Tax Return for Retirement Annuity Fund contributions. This must always be done for your RA contributions (whether or not it reflects on your IRP5).

In order to complete the RA section, you’ll need to request the IT3f tax certificate from the investment house, which will reflect the policy number and amounts you contributed.




Retirement Lumpsums


Cashing in your retirement fund prior to retirement

If you resign from your job, for example, you can still decide to cash in (withdraw) your full balance of your retirement fund savings, but you’re going to be taxed on the full amount based on special tax tables for lumpsum withdrawal benefits. Use our handy Lump Sum Tax Calculator to work out exactly how much the tax man will want. Remember, you can only early withdraw before retirement from a Pension or Provident Fund (not a Retirement Annuity Fund). The first R25 000 of these types of withdrawals is tax free.

Taxpayers are encouraged not to withdraw from funds early as the tax is quite high. It’s better to stop contributing if you’re struggling to make payments, than to take the money out and pay a lot of tax.


Cashing in your retirement fund after retirement

If you withdraw from your fund due to retirement, retrenchment or death, you’ll be taxed according to the special tax tables for retirement fund lumpsum benefits. Use our handy Lump Sum Tax Calculator to work out exactly how much the tax man will want.

There is a R500 000 once-in-a-lifetime exemption on lumpsum payouts due to retirement, retrenchment or death. So, when you retire and have not withdrawn a lumpsum before, then the first R500 000 will be tax free!

It’s important to note that ALL lump sums received from a retirement fund, whether as a result of retirement or not (and from an employer in respect of a severance benefit) are taxed on a cumulative basis. The significant impact of this is that, when you eventually retire, the total value of all the lump sum benefits received by yourself after 1 October 2007, will be taken into account when calculating the tax payable on your current retirement fund lump sum benefit.

So, if you have had two previous withdrawals of R40 000 each and you have paid tax (R10 000 on each one = R20 000 in total) then you would add the R40 000 to the new withdrawal and work out the tax. You would then deduct the R20 000 already paid and the difference would be your tax owing. All of this is based on the SARS lumpsum tables, so doesn’t get added to your normal income.


IRP5s for retirement lumpsums withdrawal, resignation or transfer.

If you retire from your retirement fund or withdraw money and receive a lumpsum, the fund will apply for a tax directive for you and should issue you with an IRP5/IT3a. In the same way, if you transfer your retirement money into a preservation fund and don’t receive any cash in your bank account, the same process will be followed, and you should still receive an IRP5/IT3a. It doesn’t matter if you pay tax or not, or if you actually receive the money in your bank account, the same process must be followed.

In all of these scenarios, SARS will record the transaction and the IRP5/IT3a will be pulled into your tax return (in exactly the same way that your salary IRP5/IT3a is included). 

So, don’t be surprised to see an extra IRP5/IT3a from an ‘unknown’ employer included in your tax return! This is simply the one issued by your retirement fund and it has details of your lumpsum withdrawal on it. The lumpsum may be coded to most commonly used source codes 3920, 3907 or 3915 and it will show on it the tax you paid (if you paid tax). Don’t worry, this lumpsum won’t be taxed again, and it won’t affect the tax you pay on your assessment, or make any refund owed to you any smaller. 

If you’re using TaxTim to help you, don’t forget to include this IRP5/IT3a when capturing your IRP5/IT3a details. If you choose the easier option (letting TaxTim import your IRP5 directly from SARS eFiling), then you won’t need to do a thing - the system will do it all for you!

How do I pay tax on my pension annuity income?

Your pension will be taxed in the same way as a salary, as per the normal tax tables for individuals. Your pension provider should issue you with an IT3a reflecting your annuity income for the year, which will be pulled into your tax return.

Unfortunately, what often happens is that the pension/fund provider doesn’t take off any tax when paying you the annuity each month. If you receive any other money from other funds, or if you’re still working, then you may receive a nasty surprise and have to pay in when filing your return. SARS are looking at making changes to this process, so that you aren’t stuck with a big tax bill at the end of tax season.



Tax Benefits on Retirements

Luckily there are quite a few tax benefits for older South African taxpayers over the age of 65 who have retired or who are still working. 

Firstly, at age 65 the tax threshold above which you begin having to pay tax is higher, at R122 300 per year in 2020 (in 2019 it was R121 000). What's more, those taxpayers who are older than 75-years-old get an even bigger break at R136 750 per year (in 2019 it was R135 300). Given the marked advantage of these higher thresholds, it would appear that SARS is starting to look out for those already in retirement. With the mandatory retirement age in South Africa sitting at 65, it would hardly be fair for taxpayers to be penalised for not being allowed to work anymore by having to pay even more tax on their savings or retirement income. SARS calls these retirement benefits secondary and tertiary rebates. 

Older taxpayers are also allowed a greater interest income exemption of R34 500.

To provide an example, it would mean that for a person of 65 years of age, the income from an investment of R2.5 million in a money market account (earning about 5% interest per year) would be below the taxable threshold. This is because the interest would be R125 000 (R2 500 000 x 5%) and then the exemption of R34 500 would be applied, to arrive at a taxable income of R90 500, which is below the annual threshold of R122 300. For many taxpayers over the age of 65 and even over 75 years old, this kind of investment may be their only source of income and therefore they would benefit greatly from this much needed tax relief.


It’s also important how SARS treats the medical expenses of older taxpayers. Unfortunately, at this age medical costs tend to be higher and so SARS has allowed ALL qualifying medical expenses (that aren't paid for by your medical aid) to count towards the calculation of the ‘additional medical tax credit’. For more information on medical, click here.

There are several other obscure tax benefits to being over 65, but these only apply to a small number of cases, while the ones listed above are seen more often. So, take heart that as you get older, some things do get easier, and you may have more money available than you think!

 

FAQs

How do I know whether I have a Retirement Annuity or pension fund?

You would either see the difference on your IRP5 or on the certificate received from the fund. For a pension contribution, your IRP5 will reflect the source code 4001, for an RA this will be 4006. Otherwise you will receive an IT3f from your fund which means it is an RA.

Does it matter if I contribute different amounts each month to my RA, or one big amount at the end of the year?

No, it doesn’t matter how or when you contribute, as long as all contributions are made within the period 1 March to 28/29 February then they will be counted towards the deduction.

Do I always get a 27.5% deduction for retirement contributions?

No, this is the maximum contribution allowed - you will receive your actual contribution up to a maximum of this percentage of Taxable Income or Gross Employment Income.

Is a tax free savings account the same as contributing to a RA?

No, a tax free savings account is an investment where you pay no tax on the interest, dividends or capital gains. A retirement fund is a way of saving for your future and you’re allowed a tax deduction for your contributions. The difference is that one is an investment and the other is a form of savings.

Must I disclose the total amount on my RA certificate, or the amount contributed for the year?

You must only show the amount you contributed for the tax year when recording your contributions on your tax return. So that means the amount contributed from 1 March – 28/29 Feb each year.

Is an IT3s a certificate about my Retirement Annuity?

No, an IT3s is for a tax free savings account and not related to your RA. The IT3f is for your RA and used for your tax return.

Must I disclose each Retirement Annuity I belong to separately or add them all together?

You need to enter each RA separately, one by one, when completing your Tax Return, as you’ll need to include the name of the fund as well as the policy number too.

What if I don’t receive the IT3a from my fund?

You will need the IT3a showing the lumpsum received or any monthly annuity paid to you when completing your tax return. Be proactive and ask them to send this to you in June each year, just before tax season starts on 1 July.