Issue: June - Aug 2013
Editorials

PERSONAL FINANCE

Treasury comes to the party

Pension-fund members will be incentivised to take home less so that they can retire on more. Niel Fourie, public policy actuary at the Actuarial Society of SA, explains how government plans to do it.

The article by Mehluli Mncube, “STRATE skewed” (TT March-May), highlights certain shortcomings in the indirect holding system used in the SA market.

To get South Africans to invest more for their retirement, National Treasury is proposing to increase the portion of retirement-fund contributions that fund members can use to reduce their annual tax. The proposal is that they be allowed to deduct up to 27,5% of their total remuneration irrespective of whether they contribute to a pension, provident or retirement annuity (RA) fund.

At present their tax-deductible contribution to a retirement fund is calculated on pensionable salary. It excludes the employer’s contribution to the employee’s fund. Now, it’s proposed, the tax-deductible portion will be calculated on the total remuneration package (also known as “cost to company”) and not only on pensionable salary.

This will lead to a higher tax deduction. It’s an incentive, planned for introduction in 2015, to invest more for retirement.

Most taxpayers investing at the maximum tax deductible percentage will then save on taxes, enabling them eventually to buy a significantly bigger pension. But until then they’ll have to sacrifice a portion of their monthly take-home pay if they’re to benefit fully from the incentive.
The challenge is to get people to save at the maximum tax-deductible levels.

How it will impact
The proposals also aim to treat all retirement funds in the same way. This will greatly simplify the retirementsaving system because at present different rules apply to pension, provident and RA funds. Here’s an overview of how the proposed changes will impact on members of pension and provident fund members as well as RA fund members.

  • Pension Funds

An employee currently contributing to a pension fund will annually be allowed to deduct up to 7,5% of pensionable salary from taxable earnings to reduce the final tax amount. In addition, the employer can boost the employee’s contributions by another 20% of pensionable salary. Therefore the total contribution deductible from annual salary to reduce tax is 27,5%.

In terms of these proposed changes, the 27,5% would be based on the employee’s total “cost to company” salary and not only the pensionable salary. This means the employee will be able to deduct more from taxable salary, resulting in lower taxes. But it will

Table A                
Tax system Total annual cost
to
comp pay
Total
annual pensionable pay
% max
tax
deductible contribution
for
individuals
Taxable salary Tax Tax deductable contribution Take home salary Retirement savings plus
salary
Current R500 000 R400 000 27.5%
(7.5% + 20%)
R390 000 R82 000 R110 000 R308 000 R418 000
Proposed R500 000   27.5%
(7.5% + 20%)
R362 500 R72 000 R137 500 R290 500 R428 000

also mean less money at the end of every month for day to- day expenses.

Say the employee earns an annual “cost to company” salary of R500 000 and the pensionable salary is 80% of this package (i.e. R400 000).

As it currently stands, the employee is allowed to contribute 7,5% of R400 000 (R30 000) to the pension fund. The employer can contribute up to 20% of R400 000 (R80 000). Therefore, the employee can deduct R110 000 (R30 000 plus R80 000) from R500 000, leaving the employee with R390 000 and a tax bill of R82 000. Take home pay is then reduced to R308 000 in that year.

On the same example, but under the new proposal, the employee’s 7,5% contribution and the employer’s 20% contribution may be based on the employee’s total “cost to company” salary of R500 000 and no longer the pensionable salary of R400 000. This would amount to contributions of R37 500 (7,5% of R500 000) and R100 000 (20% of R500 000). The employee could therefore deduct R137 500 from the salary of R500 000, leaving R362 500 that is taxable. The employee would have to pay tax of R72 000, leaving a take-home salary of R290 500.

If the new proposals had been implemented in the 2013-14 tax year, the employee would be incentivised to contribute R137 500 instead of R110 000 to his/her pension fund for that year. He/she would also pay tax of only R72 000 instead of R82 000, but the take-home pay would be R17 500 less (R308 000 minus R290 500).

Table A summarises the current scenario and compares it to the proposed tax treatment of pension fund contributions for 2015.

  • Provident funds

Fourie . . . long-term benefits

Unlike members of pension funds, members of provident funds cannot claim the 7,5% tax deduction. As it stands, the employer can contribute up to 20% of R400 000 (or R80 000) to a provident fund on the member’s behalf. On this example, the member can deduct R80 000 from R500 000, leaving him/her with R420 000 and a tax bill of R92 500. The member will therefore take home R327 500 in that year.

Using the same example, in terms of the new proposal an additional 7,5% contribution and the 20% contribution from the employer may be based on the employee’s total “cost to company” salary of R500 000 and no longer the pensionable salary of R400 000. This would amount to contributions of R37 500 (7,5% of R500 000) and
R100 000 (20% of R500 000).


The member could therefore deduct R137 500 from his/her salary of R500 000, leaving R362 500 that is taxable. After a tax payment of R72 000, a salary of R290 500 is left to take home.

Table B                
Tax system Total annual cost to comp
pay
Total annual pensionable pay % max
tax
deductible contribution
for
individuals
Taxable salary Tax Tax deductable contribution Take home salary Retirement savings
plus
salary
Current R500 000 R400 000 20% R420 000 R92 000 R80 000 R327 500 R407 500
Proposed R500 000   27.5%
(7.5% + 20%)
R362 500 R72 000 R137 500 R290 500 R428 000

On this example, if the new proposals had been implemented in the 2013-14 tax year, the member would be incentivised to contribute R137 500 instead of R80 000 to the pension fund for the year. The member would also pay tax of only R72 000 instead of R92 500, but take home R37 000 less (R327 500 minus R290 500 for 2013). Table B summarises the current scenario and compares it to the proposed tax treatment of provident fund contributions for 2015.

  • Retirement Annuities

The proposed changes will have the biggest impact on RAs. At present, contributions to an RA fund that can be used to reduce the member’s income (and therefore tax) are the greater of:

  • 15% of taxable non-retirement funding income, or
  • R3 500 less any contributions made to a pension fund, or
  • R1 750.

Take a member who is self-employed and earning R500 000 a year. This amount is considered nonretirement funding income. So while the member can currently invest only 15% of this income in an RA and deduct the contribution from salary to reduce tax, it is now proposed that from 2015 the member can contribute up to 27,5% of income and deduct this amount from salary.

Under current rules, if the member contributes 15% of income it would amount to an RA investment of R75 000 the year. If the member deducts this from the R500 000 income, a taxable amount of R425 000 is left. Assuming no other deductions apply, the tax amount would be R94 000. It would leave R331 000.

Once the proposals have been implemented, the employee will be able to contribute 27,5% of R500 000 (i.e. R137 500). When this is deducted this from salary, the employee is left with
R362 500 that’s taxable i.e. to pay tax of R72 000, leaving R290 500 to take home. Again, while bolstering retirement savings by R62 500 and benefiting from reduced tax of R22 000, take-home pay would be R40 500 less under the proposed new system.

It’s estimated in Table C that a self-employed person, saving at the maximum tax-deductible percentages, will be able to buy roughly an 80% bigger pension at retirement as a result of the proposed increased tax deductions than by continued saving at the current percentage.

Who won’t benefit?
Everyone earning up to R1,3m a year will benefit from the change. National Treasury is proposing to cap taxdeductible contributions at R350 000 a year from 2015. This will reduce tax-deductible contributions for those earning more than R1,3m a year. At present, there’s no cap.

Table B                
Tax system Total annual cost to comp
pay
Total annual pensionable pay % max
tax
deductible contribution
for
individuals
Taxable salary Tax Tax deductable contribution Take home salary Retirement savings
plus
salary
Current R500 000   15% R425 000 R94 000 R75 000 R331 000 R406 000
Proposed R500 000   27.5% R362 500 R72 000 R137 500 R290 500 R428 000