Retirees with multiple incomes need to carefully consider SARS tax directives

The South African Revenue Services (SARS) has again issued tax directives to life insurance companies stating what tax they should withhold from annuitants who receive an income from more than one source.

This means that If you receive income from sources other than your annuity, the total tax due to SARS based on your overall income will be withheld each month from your annuity to avoid a tax liability when you submit your tax return at the end of the tax year.

SARS provides life insurers with a fixed tax rate for each taxpayer to which this applies, but annuitants have the option to “opt out” of this fixed rate and then the normal pay as you earn (PAYE) tax tables will be applied.

Before you make this decision, however, there are a number of factors to consider:

Cash flow

Many retirees who draw an income from investments in a living annuity only draw the income that they require to cover their monthly cost of living.

This selection can only be made once a year and will not necessarily coincide with the beginning of the tax year.

On the other hand, individuals who receive an income from a guaranteed life annuity receive a fixed pension income with a fixed escalation rate.

The tax directive issued by SARS could have a significant impact on your monthly cash flows and it is important to review your monthly budget when determining if you are able to manage the higher monthly tax deduction.

In contrast, should you choose to opt out of the higher tax rate, it could result in a tax liability when you submit your tax return each year. The same amount of tax will be paid with either option, but how the tax is paid is what differs.

If the monthly tax deduction in line with the directive is too high, you will receive a refund but only when you file your tax return months after the tax year ends.

Consider this example:

Let's assume you are 70 years old and you have an investment linked living annuity with one provider and a life annuity or guaranteed annuity with another. Each month you receive R10 000 from the living annuity and R15 000 from the life annuity.

In the absence of a tax directive, the living annuity provider is unaware that you are receiving income from another annuity and based on the PAYE tax tables, will not deduct any tax from the R10 000 as it falls below the tax threshold. The guaranteed annuity provider will deduct just R477 in tax from the R15 000 income. You are, however, receiving a total gross income of R25 000 per month. If you were receiving this total income from one source, the tax deduction would be R2 696.

The tax that has not been deducted will have to be paid when you are assessed.

Now that SARS is considering your total income and instructing insurers how much tax to deduct, SARS will calculate your effective tax rate (11% in this case) to be deducted from each income source or annuity.  In effect, you will pay the total tax due on a monthly basis instead of on assessment.

Below is a table of the two scenarios, showing the SARS tax rate vs the PAYE rate, ignoring any other income, deductions or tax credits available each year.

Medical tax credits

If you are older than 65, you should consider the additional medical tax credits available to you when calculating your tax liability. You enjoy medical tax credits for the contributions you pay and they can be higher if you have a large amount of qualifying out-of-pocket medical expenses that you were unable to recoup from your medical scheme.

If you are expecting these medical tax credits to reduce your tax liability to nil, you may want to consider opting out of the higher tax rate to avoid unnecessary tax being deducted and the need to wait for your refund when submitting your tax return to SARS. Read more: What is a medical tax credit?

Retirement annuity contributions

If you continue to make contributions to a retirement annuity in order to get the tax relief each year, this should be factored into the calculation to determine if the tax rate provided by SARS is correct.

Read more: What are the tax advantages of contributing to a retirement fund?

If the directive tax rate is much higher, but your potential tax liability at assessment won’t be too high, it may be worthwhile opting out.

Just like everyone’s effective tax rate is unique to their income, so is everyone’s financial situation. It is important to consider your circumstances and all the factors when deciding to opt out or not.

Remember to consult your financial planner or tax practitioner to assist you when making this decision.