High income earners’ retirement reform conundrum

retirement reform conundrumWith retirement legislation set to change from 1 March 2016, high-earning executives with annual salaries above R1.27 million who are pension and provident fund members, may be affected by the newly introduced annual contribution cap of R350 000.

The deduction cap for retirement fund contributions will increase to 27.5% of the greater of remuneration or taxable income. This rate applies to the combined contributions made to a person’s pension, provident and retirement annuity funds.  “Fund members who earn more than R1.27 million per annum, may see a reduction in their take-home pay from March this year,” says Alexander Forbes Private Client Wealth Manager Craig van Zyl.

In terms of the new law, members who currently contribute more than R350 000 per year to retirement funds will no longer qualify for a tax deduction on the contributions above the cap.

There has also been a change to the Estate Duty treatment of retirement fund contributions. Whereas retirement fund benefits have previously been excluded from Estate Duty, non-deductible contributions made after 1 March 2016 will be estate dutiable, unless the member is able to deduct the after-tax contributions at a later stage. “While the contributions over and above the capped amount fall into a member’s estate and will thus be subject to Estate Duty after death, growth on this money remains Estate Duty free,” says Van Zyl.

Many people will now be wondering what the correct strategy is going forward. “You could peg your retirement savings at R350 000 and put the rest of your savings in a discretionary investment.  Alternatively you can continue to contribute above the cap and use one of the other methods referred to below of deducting after-tax contributions. If all contributions have been deducted by the time you die, there will be no Estate Duty payable.”

Van Zyl said other benefits of continuing to save in a retirement fund were that retirement fund savings are protected from creditors and free from income tax, dividends tax as well as capital gains tax.

Estate duties

After March 1 2015, estate duties of 20% will apply to non-deductible contributions to retirement funds. “Any amount contributed to a retirement savings vehicle, which did not rank as a tax deduction, will be included in the dutiable estate of a person who died after 1 January 2016,” he said.

“Individuals who contribute more in any one year can carry forward any unclaimed amounts and deduct these from tax in subsequent years, to the extent that they have not used the full deduction that year.”

Van Zyl said retirees can alternatively take a lump sum at retirement to increase their tax-free portion. “If you have contributed R1 million more than the tax allowance, you can take R 1 million tax free in addition to the R500 000 tax free which is provided by the retirement table. Alternatively, if you don’t take a lump sum, your excess contributions can be used to reduce the tax on your monthly pension income in retirement.”

“We have been running the numbers under different scenarios and have realised that each client needs to consider their own circumstances to reach the correct decision. There is no generic, one-size-fits-all approach to this.”

Related: Retirement annuity tax loophole to be closed