A simple way to reduce your personal taxMay 24, 2022
The tax officer asks you whether you would like extra cash each month with little effort on your side.
You'd probably say yes. Who wouldn't want extra cash, especially from a government entity known for only taking money? The tax officer then continues,
Each time you save money for your retirement into a regulated fund, I will give you 30% cashback.
What’s the catch?
You think about it for a moment, and then you ask what’s the catch. After all, there is no such thing as a free lunch. The tax officer smiles and says you only need to promise you will use that money for what it’s intended - for income at your retirement.
Would you take it? You probably would because not taking would be you leaving money on the table.
You leave money on the table when you take less than what is available.
Most South Africans - which might include you - leave money on the table every month as they do not take advantage of this simple retirement tax rule.
Hang on. What’s the retirement tax rule?
As part of the South African Income Tax Act, all contributions to the retirement annuity, pension or provident fund are tax-deductible - up to R350,000 a year. In simple terms, you get money back or get taxed less when you save for your retirement.
If you take a moment to think about it - the South African Government essentially gives you money for doing what is good for your financial well-being. However, very few people take advantage of this offer - which I find puzzling.
The psychological bias
This puzzling people's behaviour made me research more on what would be plausible reasons. I concluded it has to do with how our human minds are wired, particularly the loss aversion psychological bias.
Loss aversion bias
The loss aversion bias means we experience more pain from losing than the pleasure of gaining. When it comes to money, we feel more pain in losing than the joy of getting the same amount. If you don't believe me, think about the last time you played the lottery and lost R 10, and then another time you won R 10. You probably felt more pain from losing it than when you won it.
This psychological bias explains why we would not take advantage of the cashback from the South African Revenue Service (SARS). We feel more pain in saving our income - as it feels like a loss than the feeling of the gain of the tax deductions and our future income when we retire.
So, how do we overcome it?
The first step is awareness - we cannot hope to change something if we're not even aware of its existence.
- The awareness of the SARS Income Tax Act rule and how you're losing money by not taking advantage of it would go a long way.
- And the awareness of the human biases we view and assess the world around us.
Once we have awareness, we can work on changing our frame of things as either losses or gains. It's easy to view the monthly retirement savings as losses as they reduce your take-home pay. But it's a financial gain both from the tax and well-being perspective.
To help you with a mind shift and visualise the gains of saving for your retirement, we've created this free Onemoola Income Tax Calculator.