The tax-saving power of retirement funds 💪

Saving for retirement is important — so important, in fact, that the government offers a huge tax incentive to encourage people to do so. You’re eligible for this incentive if you put money into a pension or provident fund each month with your employer, or into a retirement annuity (RA).

Here’s how it works.

Tax deduction benefit

If you pay income tax, you will pay less after contributing to a retirement fund. Let’s look at two cases, both of which are applicable for the 2022 tax year.

Temba is a 30-year-old, self-employed IT contractor who earns R260,000 per year before tax. He does not contribute to a retirement fund and he will end up paying about R29,390 in tax for the year.

Lindiwe is a 40-year-old executive who works for a large company and earns an annual salary of R1,2 million. She contributes R120,000 per year to the company pension fund. Without this pension fund contribution, she would pay about R384,000 in tax for the year. Instead, she earns a R49,500 tax deduction.

Now, if Temba starts contributing R2,500 per month (R30,000 for the year) to an RA and Lindiwe contributes R60,000 more per year towards her retirement fund, perhaps also into an RA, they will each reduce their tax bill further, as shown in the table below.

By saving for his retirement, Temba will pay about R7,300 less tax for the year. Obviously, he is also ‘forgoing’ R22,700 of his income, but he’s not losing this money because it will grow and ultimately be for his benefit.

A higher-income earner like Lindiwe pays a lot more tax, but her tax benefit increases, too. By upping her retirement contribution, Lindiwe gets a further tax refund of about R24,500. Altogether, she only had to give up R106,000 of her earnings to get a R180,000 contribution into her retirement fund, with a SARS incentive totalling R74,000.

Before you put all of your income into a retirement fund, note that there’s a limit to how much you can gain. You can only contribute a maximum of 27.5% of your taxable earnings, or R350,000, whichever is lower.

But wait, there’s more!

An added benefit is that all the investment returns you receive on your retirement fund are tax-free for as long as the money is invested. This means that you won’t pay tax on any dividend or other income, or any capital gains tax on your retirement savings, all the way up until the day you retire.

Is a retirement fund right for me?

If your goal is to receive an income every month when you stop working, then making use of the tax benefits associated with retirement funds is the way to go. It’s always a good idea to consult a qualified financial advisor, who can assess your personal needs and tax requirements before you decide.

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