Lana Visser | 10 March 2023
Lana Visser, is a paraplanner at Fiscal Private Client Services. She has a B.Com in Quantitative Management and is currently studying towards obtaining a Postgraduate diploma in Financial Planning.
Each year many taxpayers take advantage of the tax benefits available when contributing to a retirement fund.
Besides the tax deduction of up to 27.5% of one’s taxable income, limited to R350 000 each tax year, another benefit of retirement funds is that all income and growth you earn within the fund is tax free. This might seem like a small benefit but it can make a big difference when investing over the long-term. Read more: Infographic: Three tax advantages of retirement fund
For those who make use of this benefit every tax year, there is a chance you may contribute slightly more than the allowable deduction, especially if you claim certain expenses against your income or earn commission that varies over time.
What happens if you contribute more than the allowable deduction? You can carry it forward to the next tax year, but what if it accumulates over time and you retire after having made a large excess contribution in total?
You need to consider how these contributions are treated by the South African Revenue Service (SARS) and how this can be a handy cash flow and tax planning tool in retirement.
How are “excess” contributions treated?
There is a specific sequence which SARS follows when dealing with excess contributions accumulated over time.
The first step is when you take a lump sum benefit from your retirement fund, or funds, at retirement.
At retirement you are able to take one third of your savings as a cash lump sum and up to R550 000 of it is tax free.
If you have made contributions in excess of the tax deductible limits, you can increase the tax-free amount you enjoy by these excess contributions. For example, if you have contributed R100 000 more than the tax deductible amounts, at retirement you can take a lump sum of up to R650 000 tax free (R550 000 plus R100 000).
If the tax-free amount plus your excess contributions exceed the one-third lump sum that you are able to take, the remaining excess contributions can be set off against any qualifying annuity income you receive as a pension once you are retired.
This means that the excess contributions you made that did not qualify as a tax deduction before retirement, can be deducted from income received from a living annuity or a guaranteed life annuity.
Remember the annuities must be compulsory purchase annuities purchased using retirement fund benefits and not voluntary purchase annuities.
If your annual income is less than the amount of your excess contributions, you will be able to earn a tax-free income in retirement.
In order to enjoy this benefit, you need to apply for a SARS tax directive and supply this to the provider of your annuity so that it does not deduct tax from your annuity income.
If you have still not offset all the excess contributions you made against your annuity income, you can deduct it from other taxable income up to the standard limits allowed for retirement fund contributions – that is you can deduct the excess contributions up to 27.5% and not more than R350 000 of any taxable income other than your annuity income.
Let’s look at an example:
Mr A has been overcontributing to his retirement annuity every year and, at retirement, he has an excess contribution of R200 000 which has been carried forward.
Mr A takes the tax-free lump sum of R550 000 at retirement and uses the balance of his retirement savings to purchase a living annuity which pays R10 000 a month. Mr A also has taxable interest of R75 000 for the current tax year.
As the tax-free amount plus his excess contributions exceed the one-third lump sum he takes, the excess contribution of R200 000 will be treated as follows:
|
Taxable income calculation |
|
| Living annuity annual income | R120 000 |
| Less deduction for excess contributions against annuity income | -R120 000 |
| Plus taxable interest income | R 75 000 |
| Less standard deduction allowed |
-R 20 625 (R75 000 x 27.5%) |
| Taxable income | R 54 375 |
The excess contribution of R200 000 is therefore reduced by the R140 625 (R120 000 + R20 625) utilised and the balance of R59 375 will be carried forward to the following tax year and treated in the same way.
Excess contributions at death
It is important to remember, however, that any excess contributions you have not been able to offset again your lump sum, annuity or other taxable income by the time you die, will be a deemed asset in your estate and will be subject to estate duty.
While excess contributions can be handy for tax planning in retirement, this is an important factor to consider in your overall financial planning.
How much you contribute to a retirement fund depends on your circumstances and your overall portfolio. It is always best to speak to a financial planner and a tax advisor before making these decisions. Read more: How can I find a good financial adviser? and Who can help me with tax advice?
