The RA top up contribution: new rules, same old benefits

The period between the calendar and tax year end is referred to as “RA season” by the savings industry. It is the time tax payers seek to reduce their income tax bill by making a top-up contribution to their retirement annuity.

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The rules around this changed in 2016, but the benefits of making a top-up contribution remain the same. For those who qualify, it’s still an easy way to reduce their tax liability, boost their savings, and earn compounding tax-free returns.

Making a top-up contribution late in the tax year had little to do with procrastination. Rather, it was the consequence of a complicated tax provision that permitted tax payers to claim RA contributions against non-pensionable income only.

Non-pensionable income is income that does not attract a compulsory contribution to an employer’s pension or provident fund. If employees do not belong to a workplace retirement fund, then all their income would be non-pensionable. Alternatively, if only their basic salary is pensionable, other remuneration such as commissions, bonuses and overtime would be considered non-pensionable. The earnings of self-employed people, as well as taxable rental and interest income also fall into this category.

Typically, it was only towards the tax year end that tax payers had a firm idea what their annual non-pensionable income would be, and the available tax deduction, hence the year-end top-up. But with the passing of retirement reform legislation, the rules of the game have changed.

Under the old regime, effective to 29 February 2016, members of retirement annuities could claim contributions up to 15% of non-pensionable income. The big negative of this (apart from the complexities of defining non-pensionable income) was the 15% limit, much less than the 27,5% permitted for a pension fund. On the plus side, there was no rand cap on the amount, and it did not matter how much you had contributed to their workplace pension or provident fund.

The new laws turn this around. The rules are much simpler – tax payers can now claim RA contributions against their entire income, and at a much higher rate (27,5%). The downside is that the total annual permitted deduction is capped at R350,000 and this includes the contributions made to a workplace pension or provident fund.

These reforms are good news for those who earn substantial amounts of non-pensionable income, as they can now claim a bigger deduction, but not so much for high-income earners limited by the R350,000 cap, or for those who already contribute meaningfully to their workplace pension.

But for many, the top-up contributions remain a viable and attractive option. Take the example of middle-aged employee paying marginal tax at 41%. Her remuneration is R1m, which allows her to claim total retirement fund contributions up to R275,000. She contributes R150,000 to her pension fund, allowing her to make a top-up contribution of R125,000. This will afford her a tax refund of R51,250 once she is assessed by SARS. Further, the interest income on the R125,000, taxed at 41%, would attract no tax in her RA, giving her a further R3,500 tax saving pa.

Both these amounts – the initial capital and the accumulated return – will of course be taxed on withdrawal, but at a maximum rate of 36% (and most likely at a much lower rate). So there is a tangible cash benefit that comes with the top-up contribution.

With the restrictions imposed by “non-pensionable income” falling away, tax payers also have more scope to add top-up contribution to their workplace pension or provident fund (rules permitting) and get the same tax benefit.

Which is more beneficial? Assuming both options have the prospect of similar returns before fees, it comes down to a comparison of fee levels (which impact hugely on the long-terms savings outcome) but also on the tax payer’s personal plans, in particular when and how they intend to access their retirement savings. For example, the RA can only be accessed from age 55 onward, a workplace retirement fund at any time on leaving the employer.

Either way, the year-end top up contribution remains a compelling way for most tax payers to achieve immediate tax savings and improved prospects of a financially-secure retirement.

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