I have a retirement annuity (RA) to which I make occasional contributions. What is the benefit of ‘overpaying’ for a particular year? Let’s say I usually deposit R40 000 into an RA to maximise the tax benefits for that year. But then, instead, I make a payment of R200 000 for that year and nothing the year after. Is the tax benefit automatically rolled over to the next financial year (so I would get the R40 000 back from Sars the next year, even though I made no additional payments), or would I only get this tax benefit when I convert my RA to a living annuity one day (then pay less tax then)? Or is there no benefit?
Thank you for your question. In answering it, we will discuss how Sars will treat excess contributions above your tax-deductible limit towards your RA.
The method by which you calculate your tax-deductible contribution for the tax year is by calculating your total taxable income for the tax year in question. The contribution is limited to 27.5% of the greater of your remuneration or taxable income, and this contribution is capped at an annual limit of R350 000.
In a year of assessment where your maximum tax-deductible contribution towards your respective retirement fund is R40 000, and you make a contribution above that, let’s continue with your example above and assume you contribute R200 000 in that tax year, R160 000 would roll over as an overcontribution. Should your maximum allowable tax-deductible contributions be R40 000 again in the following tax year, R40 000 of your overcontributions would qualify as a tax deduction to reduce your taxable income for the tax year, and R120 000 would roll over into the next tax year, and so on.
Besides locking in future tax deductions while cash flow allows you to, some investors will overcontribute to their RAs in order to benefit from the potential growth that is exempt from all taxes inside the retirement annuity.
If, on reaching retirement age, you decide to retire from your RA and you still have an amount that qualifies as an overcontribution, the tax deduction is calculated slightly differently. This is because the fund rules allow you to take up to one third of the value of the retirement fund in cash only. The cash lump sum decided on will be taxed at the retirement lump sum tax table, where the first R550 000 is taxed at 0%. This tax table is applied over one’s lifetime and includes any prior severance benefits received and lump-sum cash withdrawn.
The amount that was in excess can be used to offset the tax payable in terms of the retirement lump sum tax tables. This means you can receive more lump sum cash taxed at 0% when retiring from the fund, assuming that this value is still below the one-third maximum that the fund rules allow you to take as cash. If the amount exceeds the one third that you can take, then the remaining overcontributions can be used to offset any tax payable from the taxable income drawn from the annuity that was purchased with the remaining two thirds.
If you were to pass away after making these excess contributions to a retirement fund, should your beneficiaries elect to take the benefit as a cash lump sum, the sum is taxed in the name of the deceased according to your retirement lump sum tax tables. Similar to you retiring from the fund, your beneficiaries will be able to elect to take cash and reduce any tax due by any excess contributions that were made before your death. However, excess contributions cannot be carried over to reduce tax payable from the taxable income drawn from the annuity, as the annuity income is now taxed in their hands.
As explained above, there are many considerations when making overcontributions towards retirement funds. We hope that this answers your question.
Dear reader,
Contributions to an RA are tax deductible up to a certain limit, currently 27.5% of your taxable income or gross remuneration, with a maximum limit of R350 000 per year. Contributions over these limits will be carried over to the following years of assessment, to be applied to reduce that respective year’s taxable income.
Should you retire and have excess contributions that have remained ‘non-deductible’, these contributions can be added to your tax-free lump sum portion. The current tax-free lump sum portion is R550 000. Non-deductible contributions can be added to the tax-free portion and paid out tax-free, provided the lump sum does not exceed one third of the total RA fund value. If it does exceed one third of the RA fund value, then you will restricted to drawing only one third of the RA fund value as a lump sum.
If the non-deductible contributions are not taken as a tax-free lump sum, then your income drawdown will be tax-free up to the amount of the non-deductible contributions.
For example, let’s assume that at retirement, your total non-deductible contributions add up to R300 000, and you do not draw this as a lump sum or cannot draw this as a lump sum due to the one-third restriction. Let’s also assume that your income drawdown is R25 000 per month. This income will then be paid to you tax-free for 12 months (R25 000 * 12 = R300 000). Thereafter, only will the income be taxed.
Should you make excess contributions?
In evaluating whether one should make excess contributions to an RA, I would like to highlight a few key features of RAs that should be considered.
Investment growth in RAs is tax-free. The compounding effect of tax-free growth within a RA can significantly enhance the final fund value, especially if there is a long-term time horizon.
However, RA funds are not accessible until age 55. This is an important consideration, and your objectives and circumstances need to be considered before determining how much to invest in an RA.
RAs are protected from creditors. This can be an attractive feature for anyone exposed to that type of risk.
RAs need to abide by Regulation 28 of the Pension Funds Act. This restricts the asset allocation to equities to 75% and global assets to 45%. This asset allocation restriction may reduce investment returns over the long term compared to what a 100% equity allocation, for example, could generate.
On death, RA assets are not estate dutiable and do not have to be paid into the estate. As a result, beneficiaries do not have to wait until the estate is wound up and can access the funds much sooner. Beneficiaries can receive the funds as a lump sum, in which case they will pay tax as per the retirement tax tables. Alternatively, they can convert the retirement fund into a living annuity. The transfer of the assets to the living annuity is tax-free, but the income the beneficiary receives is then added to their taxable income for the year and is fully taxable.
In conclusion, there are many factors to consider when deciding which investment product is most suitable for your circumstances and objectives. There are many investment products available on the market that you can use to grow your wealth, and an RA is only one of them. The pros and cons vary across the many products, and it may be worthwhile to get professional advice to determine the most suitable product for you.
You are welcome to contact us should you have any questions or would like any advice.