How saving for retirement can reduce your taxes
With the 2016 tax filing season now open, many South Africans will be gearing up to complete their income tax returns. However, before clicking the ‘Submit’ button, now may be a good time to remember that tax legislation allows you to claim certain expenses against the income you received during the tax year. Doing so may reduce your overall tax liability, which means paying less tax to SARS or even getting a refund.
How the government incentivises us
The type of consumer spending the government encourages generally helps support the economy in some way or the other. For example, to reduce the strain on the country’s pension and healthcare systems, the government allows individuals earning a salary to receive a tax deduction for contributions made towards a retirement fund and medical scheme. Similarly, to encourage small business growth, individuals who are involved in a specific trade can claim certain expenses relating to the production of that income.
The type of expenses that you can claim for is largely dependent on the type of income that you receive. For example, if you receive a salary, some of the expenses that you may be able to claim for include:
- Retirement fund contributions
- Medical scheme contributions and expenses
- Certain legal costs relating directly to your salary
- Depreciation of certain assets used regularly to do tasks relating to your job
- Donations to approved public benefit organisations
One of the more common methods that salary earners use to reduce their overall tax liability is to contribute to an approved retirement fund. A benefit of this method is that members are effectively paying the contribution to themselves while at the same time increasing their retirement savings.
Earlier this year the government increased the maximum amount that retirement fund members can claim as a tax deduction to the greater of 27.5% of the member’s remuneration, or 27.5% of their taxable income (subject to a maximum limit of R350 000). These limits are effective from 1 March 2016.
Even if you aren’t able to contribute the maximum allowable amount, the below example shows how saving even a small amount can help reduce your overall tax liability.
John is a 35-year-old individual taxpayer who received a salary of R400 000 and a cash bonus of R50 000 for the 2015/2016 tax year. As his employer does not contribute to a retirement fund on his behalf, to reduce his income tax liability he decided to contribute a total of R30 000 to a retirement annuity fund. The table below shows how much he saved in income tax by saving towards his retirement.
Based on the above, John was able to save R10 800 in tax by contributing to his retirement annuity fund. Another way of looking at it is that John contributed R30 000 towards his retirement at the reduced price of R19 200 (R30 000 less the R10 800 he received as a tax deduction); this works out to a 36% discount!
Saving towards retirement can pay off in the short term – in the form of a tax deduction – as well as in the long term.
If you are unsure about whether or not you can claim certain expenses against the income you received, or if you have any questions about your tax submission, we recommend contacting your financial adviser for more information.
Keep a look out in October for our soon-to-be published article on post retirement options and the tax implications thereof.