Retirement fund excess contributions have become a hot topic lately, as they are a tool for investors to achieve tax-free growth on their savings, receive tax-free income and potentially pay less estate duty on their passing.
While utilising excess contributions can be tax-efficient in the short term, there are important long-term factors to consider. In this newsletter, we unpack what excess contributions are and how they affect retirement planning.
What are excess contributions?
Excess contributions are amounts you contribute to a retirement fund that go beyond what SARS allows you to claim for a tax deduction each year. This means you’re still saving for your retirement, but you won’t get an immediate tax benefit on the extra amount invested.
The current limit is the lower of 27.5% of your taxable income or remuneration, with an overall cap of R350,000 per year. Your excess contributions will keep rolling over each year to become allowable contributions, providing tax deductions in future years.
TAX PLANNING
Tax benefits of utilising excess contributions:
- Tax-free returns on money invested: The money you invest grows completely free of tax—you pay no tax on the interest, dividends, or capital gains it earns.
- Lower tax when drawing a retirement lump sum: When you retire, the cash lump sum you take (up to one-third of the fund) will include excess contributions, which are taken tax-free.
- Tax-free monthly income in retirement: Excess contributions fund your income at the start of retirement, which is free of tax.
Tax concerns of utilising excess contributions:
- Tax-free income has limits: Over time, your excess contributions pot will be depleted, and your income will become fully subject to tax once depleted.
Excess contributions are a powerful tool to lower tax on your savings while they grow and to secure a potentially large tax-free cash lump sum at retirement. However, you must plan carefully, as the tax-free status on your monthly income will eventually run out, and the income will become taxable.
ESTATE PLANNING
Estate benefits of excess contributions:
- Beneficiary nominations on your money: You get to directly choose who receives the money when you pass away, which helps ensure the funds go where you intend without delay. No executor involvement applies.
- No estate duty when beneficiaries inherit retirement funds: Because the money is housed in a retirement fund, it bypasses your formal estate. This means your beneficiaries save on high inheritance taxes (estate duty) and executor fees.
Estate concerns of using excess contributions:
- Estate duty can turn into retirement tax: When a beneficiary draws their benefit as cash, the tax they pay is dependent on how much of the fund is still an excess contribution. The excess contribution portion will remain subject to estate duty (20% – 25% and tax-free for spouses), but the rest of the fund will be subject to the retirement tax table (up to 36%). In other words, over time, more and more of your capital becomes subject to a higher tax rate on death.
- Beneficiary income becomes fully taxable: When a beneficiary keeps their benefit as a retirement fund instead, they will receive their benefit in the form of a Living Annuity income, subject to income tax of up to 45% – tax-free income does not transfer to beneficiaries as the excess contributions portion only applies to you.
This structure is excellent for protecting large amounts of capital from high inheritance taxes and fees, provided your beneficiaries elect to receive their benefits as a monthly annuity income. If they opt for a cash payout, they will trigger a large tax event, potentially eroding the benefit.
OTHER CONSIDERATIONS
- Access is limited: Your money is completely locked away until you retire. You cannot withdraw it for emergencies, large purchases (like property), or medical expenses. Even after retirement, you are limited to taking one-third as cash, with the rest providing a monthly income between 2.5% and 17.5%.
- You may only invest locally: Retirement funds must hold most of their assets in South Africa. This prevents you from diversifying your capital globally (offshore).
- Not transferable after death: Excess contributions cannot be passed on to your beneficiaries and all monthly income they receive will become fully taxable.
The trade-off for the strong tax and estate benefits is a lack of flexibility and liquidity. Retirement funds should only be used for money you are certain is intended for regular retirement income. Other vehicles like local and offshore wrappers should be considered as alternatives to provide more access and global exposure.
Conclusion: Balancing Opportunities with Flexibility
Excess contributions can be a powerful tool to reduce taxes, grow your savings, and pass wealth to the next generation. However, as the scenarios show, they also come with important restrictions—particularly around access, offshore diversification, and how they are taxed on death.
That’s why it’s worth weighing them against alternative vehicles such as local or offshore investment wrappers, which can offer greater liquidity, global exposure, and more flexible estate planning options.
All investor’s circumstances are unique, and the “best” solution often lies in combining different strategies. Speaking to a qualified financial planner can help you assess how excess contributions fit into your broader retirement plan and whether wrappers or other structures may add more balance and flexibility to your portfolio.
If you’d like to explore which mix of retirement and investment vehicles works best for your goals, let’s start the conversation.
