Tax year-end alert: Have you maximised your tax deductions?

February is the month to do some tax calculations and make sure you make the most of the tax breaks you enjoy each year.

You may be able to save tax by adding to your retirement savings and should take advantage of contribution limits to a tax free savings account, and for realising capital gains.

1. Retirement contributions

Each year you are entitled to contribute just less than 30% of your income to a retirement fund. The tax saving on your contributions is at your marginal tax rate.

This means if your highest tax bracket is 41%, you could save 41 cents in tax for every rand that you contribute to a retirement fund up to a certain limit. (If your taxable income is between about R850 000 and R1,8 million this tax year – your marginal tax rate is 41%.)

If your marginal rate is 31%, you will save about 31 cents in tax for every rand you put in your retirement fund up to the limit (if you earn between R370 500 and R512 800 a year).

The limit for the tax deduction is contributions equal to 27.5% of your taxable income or R350 000 a year. Most working South Africans are not contributing anything near this amount.

In an article published by Allan Gray this month, Carla Rossouw,  head of that investment house’s tax team, shows the tax saving for someone earning R480 000 a year or R40 000 a month. Let’s call that person SAM. Without saving anything in a retirement fund, 23% of SAM’s salary would be deducted for tax. But saving 15% - or R6 000 a month in a retirement fund, reduces SAM’s tax to 19% - a saving of R1 860 a month.

If SAM contributes R6 000 to an employer-sponsored fund, SAM will only give up R4 140 of their take-home pay to make that contribution.

Lara Warburton, managing director of Integral Wealth and the latest winner of the Financial Planner of the Year award, says retirement funds are the best savings vehicles for higher earners and those close to retirement. You enjoy the tax deduction in the tax year you contribute and your savings grow tax free. Read more: What are the tax advantages of saving for retirement? and How do retirement annuities allow me to create my own retirement savings?

How can you afford to save

In a recent survey by 10X for its Retirement Reality Report, 70% of South Africans surveyed said they did not contribute to a retirement fund because they could not afford to.

Unless your income covers necessities only, you are making spending choices. Choosing to spend now on things you want instead of saving for retirement, will limit your future spending. If you save nothing you may be forced to live on the social old age grant or you will have to contribute much more at a later age to catch up on your retirement savings.

Start by finding a small amount in your budget to save each month and increase the amount with each salary increase. Use any tax refunds or tax savings to add to your retirement savings.

Any once-off amount you receive – a bonus, a gift, an inheritance, the profit on something you sell – can also kick start your retirement and tax savings.

Use our Tax deductible retirement fund contributions calculator to work out how much you can contribute.

2. Tax free savings accounts

Each year you can contribute up to R36 000 to a tax-free savings account until you reach the life time limit of R500 000. If you haven’t yet made use of that full amount for the year, February is the last month of the tax year to do so.

Although you can only contribute R500 000 in total, with tax-free growth your investment can grow well beyond this amount and it can be withdrawn without any capital gains. Read more: What do I need to know about investing in a tax free savings account?

The benefit of a tax free savings account is in the long-term tax-free compounding growth over time – at least five to eight years – possibly longer if you are investing in high-growth assets like local or offshore equities in a unit trust, Warburton says.

Equity or high equity multi-asset funds earn little taxable income, but you should prefer them to bank products to earn higher growth on longer-term investments, she says.

Tax free savings accounts make sense for young people starting out, but a simple rule of thumb is to use them if you will have R200 000 or more invested for 10 years or longer, Warburton says.

If you are investing for a shorter term – to buy a property, for education costs or you plan to emigrate – the benefits may not be worth using up your tax free savings account lifetime allowance, she says.

Remember that you can use the annual interest exemption of R23 800 for under 65’s and R34 500 for over 65-year olds. If you are under 65-years old, you can have about R300 000 earning 8% a year in interest without it being taxable, Warburton says.

Finding the money to save

Finding R36 000 a year may be a big ask, so remember this:

• You can contribute any amount up to R36 000 – start with what you can.
• Contributing monthly makes it easier and you can make a monthly contribution of any amount up to R3 000 a month for the full year.
• If you do not have the money to contribute, consider switching discretionary investments – those not in a retirement fund – into a tax free savings account.

3. Capital gains tax exemption

Every year you are entitled to make R40 000 in capital gains tax free. Long-term savers may find their gains exceed this annual exemption. You can make the most of the exemption by sell or switching your investments over more than one tax year, but Warburton cautions against selling good investments purely for tax reasons.

But if you have good reasons to make an investment change – because you need to take more or less investment risk (your risk profile has changed), you need to sell an underperforming fund or you are planning a withdrawal – then it is a good idea to consider timing the transaction to minimise the CGT impact, she says.

The CGT payable must outweigh the opportunity cost of switching investments and the days you may be out of the market, Warburton says.

Remember that the effective CGT tax rate is low - a maximum of 18.8% for top earners - compared to dividend withholding tax at 20% and income tax on interest above the exemption at marginal tax rates from 18% to 45%, Warburton says.  Read more: What is capital gains tax?