Capping effects on retirement fund contributions

There is much talk in financial planning circles about the effect of making non-tax deductible contributions to retirement funds. Some say without the tax break a retirement fund contribution simply makes no sense at all.

The proposed new rules for tax-deductible contributions to retirement funds, effective from 1 March 2014, provide for an increased overall contribution level of 27,5% of taxable income (previously 15-22,5%.) Thus the new rules will benefit most South Africans. However, tax-deductible contributions may not exceed R350 000 per annum. Thus taxpayers with taxable income exceeding R1,27 million per annum are potentially vulnerable to ‘capping’. This affects about 60 000 South African taxpayers.

Prior to the implementation of ‘capping’, taxpayers are well-advised to consider additional contributions. In particular, taxpayers with substantial unexercised share options may benefit substantially by exercising options prior to 28 February 2014 and contributing 15% of the taxable income to a retirement fund. This can reduce the effective rate of tax on share option income from 40% to 34%.

But will a contribution of R350 000 p.a. buy a pension annuity sufficient to maintain the lifestyle of a high net worth taxpayer? Take a monthly contribution of R31 250 over 25 years, growing at 5% per annum, return rates of 10% and inflation at 7%. The answer is R10,8 million retirement capital in today’s money.

Today, the general rule of thumb is that a retirement fund withdrawal should not exceed R6 000 per month per R1 million of retirement capital. So the above contributions would yield a taxable annuity of around R60 000 per month or R720 000 p.a. Post taxation this would be R527 330 per annum or R43 944 per month. The above may buy seats for two at the bingo game in the shady pines retirement home, but it will not be enough to pay for the two homes, an ex-spouse (or two) and four grandchildren in private schools – all acquired during a working life. At least not without eroding the retirement capital very quickly.

A further problem is that few will ever earn R1,27 million p.a. for 25 years. The lucky few will achieve this for maybe 15 years. The solution is to contribute to retirement funds for longer. By way of comparison, a contribution of R20 100 over 35 years will achieve approximately the same capital as the above R31 250 over 25 years.

Of critical importance is that National Treasury must increase the cap of R350 000 upwards every year to take account of inflation. It must not be left to stagnate, as is the case with the 2nd schedule tax rates on lump sums that have hardly been revised since they were introduced in 2007.

Building a retirement plan

The new amendment makes it all the more imperative to build up a retirement plan over the longest possible term. Playing ‘catch-up’ in the 15 years prior to retirement may not be achievable via a fully deductible retirement fund contribution. Even if a retirement fund contribution is not tax deductible, three further tax aspects must be considered:

  • The capping of retirement fund contributions does not result in the tax benefit being permanently forfeited. Disallowed contributions to retirement funds may be carried forward to a subsequent year of assessment and may thus become deductible at a later stage. Now that tax-deductible contributions can be made to retirement funds beyond the age of 70, the tax deductions on contributions can even have value in retirement.
  • Accumulated non tax-deductible contributions will ultimately be added to the tax-free lump sum on retirement. And a 2012 amendment to the Income Tax Act allows for the apportionment of a taxable annuity to compensate for disallowed contributions.
  • Growth within a retirement fund is exempt from taxation (inclusive of dividends tax and capital gains tax), thus increasing the investment return of retirement funds. The abolition of retirement funds tax in 2007 and the dividend tax exemption granted to retirement funds (effective 1 April 2012) have a collective tax cost to National Treasury of +/- R12 billion per annum. This concession costs National Treasury even more than the tax deductions granted on contributions. But it is up to the taxpayer to claim a slice of the action!

The tax saving offered by the retirement fund tax exemption differs, dependent on the type of alternative investment vehicle:

  • Individuals – revenue income (up to 40%)
  • Individuals – capital income (up to 13,3%)
  • Trusts – revenue income (flat rate of 40%)
  • Trusts – capital income (flat rate of 26,6%)
  • Insurance policies – Revenue Income (up to 30%)
  • Insurance policies – capital income (up to 10%)

The effect of the tax exemption offered by a retirement fund can be staggering in the long term.


  • Tax-free investment in a retirement fund (R10 000 per month)
  • Investment term (30 years)
  • Growth in contributions (5%)
  • Inflation rate (6%)
  • Return rate (12%)
  • Present value of investment after 30 years (R8,14 million)

If the same example is used over, but the return rate is reduced to 10% due to the taxation of investment returns if the investment is made by an individual taxpayer, the sum changes:

Present value of investment after 30 years (R5,78 million)

Do not underestimate the value of the tax-free return inherent to retirement funds over the long term!

Estate Duty

Further concessions inherent to retirement funds take the form of estate duty and capital gains tax exemptions on death benefits paid by a retirement fund. Collectively these taxes can amount to 25% of the value of an estate, depending on the tax and wealth profile of the deceased.

Trusts have traditionally been the estate-planning vehicle of choice. However, the effectiveness of trusts in estate planning has complications:

  • In general, trusts are more expensive to administer than retirement funds.
  • Income received by a trust remains taxable in the hands of the donor, beneficiary or trust.
  • A taxpayer cannot simply donate assets to a trust and be done with the problem. Assets must be transferred into the trust at full market value. Only the growth within the trust will be shielded from taxation. A retirement fund contribution results in an immediate estate duty saving.
  • In the 2013 National Budget Speech it was announced that the taxation implications of trusts would be reconsidered. This has not happened in the 2013 draft Taxation Laws Amendment Bill. But the matter has been referred to the newly appointed Davis Tax Committee for further consideration.

Liquidation of the investor

Retirement fund benefits fall outside of any liquidation proceedings brought against a taxpayer. The value of this is dependent on the taxpayer’s business risk profile but should nevertheless always be considered.


Obviously, the tax deductions granted on contributions to retirement funds are a substantial incentive. But they are by no means the be-all-and-end-all of the matter.

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