What are the tax advantages of contributing to a retirement fund?

Key takeaways

  • Contributing to a retirement fund will entitle you to a tax deduction.

  • Tax deductions are limited to 27.5% of you remuneration, or taxable income with the ceiling on contributions being R350 000 in any tax year.

  • Savings in your retirement fund grow tax free.

  • You can withdraw a lump sum tax-free at retirement and tax on your pension will be lower than that in your earning years.

It is worth knowing what the tax advantages are to saving in a retirement fund, because the incentives you enjoy can make a big difference to the outcome of your attempts to provide yourself with an income in retirement.

Infographic: Three tax advantages of a retirement fund

Knowing the tax disadvantages of withdrawing your savings from a retirement fund may also influence your decision about what to do with your savings in an employer-sponsored fund when you leave a job. Read more: Why is withdrawing from my retirement fund a bad idea?

It is also important to understand the tax you will pay on your retirement fund savings at retirement when you withdraw money or convert it into a pension. Tax is payable, but typically at a lower rate than the tax you would pay if you paid the tax now and saved the after-tax amount. Read more: What tax will I pay when I retire?

There are three ways in which you get a tax advantage from saving in a retirement fund:


1. Tax deductions for contributions

Taxpayers who make contributions to a retirement fund enjoy a tax deduction up to certain limits.

This includes contributions made to a retirement annuity, pension fund and provident fund.

If you contribute within these limits, it means you will save a certain amount in tax for every rand you contribute – anything from 18c to 45c depending on your marginal tax rate.

The contributions you can deduct each year are 27.5% of your taxable income or remuneration, whichever is the highest, subject to a limit.

This limit is a maximum contribution that qualifies for a tax deduction that is currently R350 000 a year. You may reach this limit if your remuneration is above R1.27 million.


What's included

Contributions to your fund made on your behalf by your employer are included in these limits. Any amounts contributed by your employer are added to your salary as a taxable fringe benefit, but can be offset by the tax deduction, as long as the amounts both you and your employer contribute are within the limits allowed for the deduction.

For the purposes of calculating your tax deduction for retirement contributions your remuneration includes your salary, overtime pay, allowances, leave pay, bonus, fringe benefits and any gratuities or commission before any deductions.

If you are retired, your remuneration will be your pension.

Your taxable income includes all your income including rental, investment and business income, less any exempt income and deductions plus your taxable capital gains.

Your taxable income will be higher than your remuneration or your pension, if you earn rental income, interest income or made any taxable capital gains.

How you claim the deduction

As a salary earner contributing to an employer-sponsored retirement fund, you will enjoy this tax deduction immediately and it will reduce the pay as you earn (PAYE) tax deducted from your salary each month.

As a contributor to a retirement annuity (RA), you will be able to claim the tax deduction when you file your income tax return and, if you are a provisional taxpayer, you can reduce your taxable income by the amount you have contributed.

If you are a salary earner contributing to an RA, you can ask your employer to adjust your monthly PAYE to take into account of your contributions to an RA.


Excess contributions carry over

If you contribute more than the tax deduction limits to a retirement fund, the excess amounts can be carried over to the following tax year and, if within the limits, used as a tax deduction in that year.

Any amounts you contribute to a retirement fund that you have still not claimed as a deduction by the time you retire, can be used to reduce the tax you need to pay on any cash lump sum you take before, or at retirement.

Alternatively, you can use the contributions you have not been able to deduct from your taxable income as a deduction from the taxable portion of your annuity (pension) income in retirement. 

2. Tax-free growth

Amounts you contribute to your retirement fund can earn interest, dividends and make capital gains without incurring tax.

Compounding over many years, this can enhance your savings enormously.

This tax concession also applies to contributions you make to a retirement fund that are not allowed as a tax deduction because they exceed the allowable limits.

3. Tax concessions at retirement

When you retire, you can withdraw a lump sum equal to one third of your retirement savings. There are some exceptions for provident fund members who were members before March 1 2021.

Up to R500 000 of that lump sum can be taken tax free. This tax-free amount is reduced by any lump sums you have taken previously as a withdrawal on resignation from your job, or on retrenchment.

If you retire after the age of 65, the tax you pay on the income you receive as a pension or annuity will be reduced, as taxpayers over the age of 65 enjoy further tax rebates.