It’s a common misconception that contributing to a pension or retirement fund means you get money back from SARS. It makes it seem like pension fund contributions trigger a cash rebate. In reality, contributions to retirement funds reduce your tax liability. The reason you get money back at the end of the year is because you are in a lower tax bracket. Since you paid tax at a higher level through your pay-as-you-earn (PAYE) contributions, the money you get back is basically a refund.
This is great news, because it means you might get the benefit of a lower tax bracket while contributing the maximum allowable 27.5% to your pension product. In addition to that delicious refund, a lower tax bracket also has implications for how much tax you pay on capital gains and interest.
In this post we are going to help you work out by how much your tax liability would reduce if you contributed higher or lower amounts to your Regulation 28-compliant retirement savings product. For the sake of this calculation, we are going to assume that your salary is the only income you earn during the year. We do this because your retirement fund contributions are deducted from your net income, which accounts for additional sources of income like rental income and dividends.
[This is relevant for 2020 – check SARS for your current liabilities!]
For the sake of this example, we are going to assume you earn R20,000 before tax.
- Annualise
To run this calculation, you have to start by multiplying your monthly income before tax by 12, to get your annual income.
20,000*12 = 240,000
Your total income for the year is R240,000.
- Find your tax bracket, before retirement savings
To get to what you’ll actually be saving, you have to figure out what you would have paid if you made no retirement fund contributions. You do that by finding your income band in the latest tax table, an up-to-date version of which is available on the SARS website. According to the table below, if you contributed nothing to a retirement fund, you would fall into the 26% tax bracket. 
You’ll notice that a flat rate of 26% isn’t applied to all your money. Every rand you earned up to 205,900 was only taxed at 18%. This is what people mean when they talk about our “progressive tax system”. The rand amount you see before the 26% is 208,900 times 18%.
Every rand above 205,900 would be taxed at 26%. Therefore:
240,000-205,900 = 34,100
Now apply the 26%
34,100*0.25 = 8,866.
To this you still have to add the lump sum that accounts for the money taxed at 18%.
37,062+8,866 = R45,928.
The primary rebate and medical aid rebates are deducted from this amount, which gives you your final tax liability.
- Calculate the maximum allowable retirement fund contribution
The beauty of contributing to a Regulation 28-compliant retirement product is that you can deduct your annual contribution before applying the nasty tax table. You are allowed to contribute up to 27.5% of your annual income (up to a maximum of R350,000) to a retirement product and then deduct those contributions from your income.
240,000*0.275 = 66,000.
- Deduct the retirement fund contributions from annualised income to get your taxable income
240,000-66,000 = 174,000.
- Decide how much you’d like to contribute
As you can see, a 27.5% contribution not only drops you into a lower tax bracket, it reduces the amount of tax you’d have to pay in that bracket too. Not everyone wants to contribute their full discretionary budget to a retirement product. You might prefer to invest in some ETFs instead, for example.
Calculating your annual income, your allowable retirement fund contributions and understanding your tax bracket can help you make a decision about how much money you’d like to contribute to a retirement product.
In our example, contributing 15% would be sufficient to drop you into the lower tax bracket. You can contribute the rest towards discretionary investments.
Wealthy Maths blog
Many of us avoid making financial decisions because we worry that we can’t do the maths. Luckily, there are only a few formulas you need to understand to make a good financial choices. This series of articles is dedicated to helping you understand how to do the calculations for yourself. Once you grasp these simple formulas, you can make better financial choices on the fly.