The more you earn, the greater your retirement tax benefit
As most people know, contributing to your retirement fund through either a retirement annuity, pension fund or provident fund can have great tax benefits. However, what is not commonly understood is that the higher your marginal rate of taxation, the greater your benefit, says Daniel Baines, author of ‘How to Get a SARS Refund’.
For the purposes of the examples below, it does not matter whether you have made the contributions to an RA/pension or provident fund, he said.
This effect is best illustrated by means of practical examples:
Example 1 – Salary of R240,000 per year and contributing R24,000 per year to an RA
Individual A – Contributes to an RA
- Salary: R240,000
- Contribution to RA: R24,000
- Taxable Income: R216,000
- Tax paid: R40,492 (not taking the rebate into account)
Individual B – Does not contribute to an RA
- Salary: R240,000
- Taxable Income: R240,000
- Tax paid: R46,732 (not taking the rebate into account)
In example 1, Individual A has saved R6,240 on tax for the year. This is 26% of the amount contributed, being R24 000. In other words, because the person’s marginal tax rate is 26%, they have reduced their tax liability by 26%.
Example 2 – Salary of R480,000 and contributing R48,000 to an RA
Individual C – Contributes to an RA
- Salary: R480,000
- Contribution to an RA: R48,000
- Taxable income: R432,000
- Tax paid: R103,395 (not taking the rebate into account)
Individual D – Does not contribute to an RA
- Salary: R480,000
- Taxable Income: R480,000
- Tax paid: R120,675 (not taking the rebate into account)
In example 2, Individual C has reduced their tax payable by R17,280 or 36% of the amount contributed, being R48,000.
“In other words, because the person’s marginal tax rate is 36%, they have reduced their tax liability by 36%,” said Baines.
“While it may feel unfair that you are taxed at a higher rate than an individual earning less than you, you can use your retirement contributions to reduce your tax liability.
“If you are already contributing the maximum amount allowed by your employer through your employer provided pension/provident fund, you can open a retirement annuity and make additional contributions to that fund,” the tax expert said.
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