When you are nearing retirement or, at least, when you are within 10 years of retirement, you will probably start to wonder if you have catered sufficiently for your retirement.
If you decide you need to add more to your existing retirement pot you do have some options. One would be to ask your employer to look at a deferred compensation scheme for you. The other would be to increase your contributions to your current retirement fund.
So, how do you go about doing these as tax efficiently as possible?
Deferred compensation involves your employer investing a monthly amount into an insurance product that will mature on your retirement. The contributions will be deductible in your employer's tax computation.
When, in the future, your employer receives the lump sum from the insurance company, it will have to include that sum in its taxable income. However, it will pay the sum over to you and, because you company's intention in taking out the policy was to pay the proceeds to you and thereby ensure your continued commitment to the company up to your retirement, the payment to you will be tax deductible in your employer's hands. This will leave your employer tax neutral.
You will receive a lump sum on retirement representing the proceeds from the insurance product. This will be taxable in your hands, but because it is paid on your retirement up to R30 000 will be tax free (provided you have not already used this exemption against another lump sum which qualifies for the exemption). Any balance will be taxed at the higher of your average tax rate in either the year you retire or the preceding year.
If you decide to go this route you cannot expect your employer to start paying into the insurance product out of the goodness of his or her heart! This is because your employer will be remunerating you on the basis that the cost, to him or her, of remunerating you represents your value to the business. Your employer will not be willing to increase this merely because you wish to increase your future retirement benefits.
Consequently, it will be necessary to request your employer to pay your monthly salary at a level which will compensate him or her for the fact that the monthly contributions are being made to the insurance company. As I have discussed in previous articles it is important that any salary restructuring is done properly. Ideally you should only forgo an increase your employer wants to give to you. It is important that money that has already accrued to you as salary is not just re-allocated.
It is also important to be aware that if you forfeit increase contributions to retirement funds and, if applicable UIF etc, it will be based on the salary without the increase and not on the increased amount.
Which brings us to the other option to increase your contributions to your retirement fund. The amount that you or your employer is able to contribute to the fund will depend on the rules of the fund. An increased contribution could be made out of a bonus, which, if it is a pension fund, may mean that the additional contribution may be deductible for tax purposes.
If your employer is permitted to increase its contribution (probably on the basis of forfeiting an increase) then it is important to remember that its total contribution to benefit funds (which includes medical aid contributions) should not exceed a maximum of 20 percent of your total remuneration. If 20 percent is exceeded your employer may have a problem deducting the contributions.
If you have non-pensionable income you may wish to contribute to a retirement annuity fund (a contribution not exceeding 15 percent of such income would be deductible). Alternatively, if you don't have non-pensionable income you could contribute R1 750, which would be tax deductible.
Any increased contributions that you make which are not tax deductible at this stage will be deducted from the taxable portion of the lump sum paid to you on retirement.
Ultimately, it is clear that careful planning is needed to ensure you maximise the tax efficiency for catering for your retirement.