How to be tax savvy with pension plans

It is common knowledge that employees with pension schemes pay less income tax compared to those without the plans.

The income tax disparity may vary according to salary brackets but the bottom line is that pensionable employees pay less tax.

Take for example two individuals per earning Sh100,000 every month.

The one on a pension scheme is deducted Sh10,000, assuming a 10 per cent contribution rate and because of tax relief, his pay-as-you-earn (PAYE) is at Sh22,094 while the other individual without a pension scheme pays Sh25,094 in income tax because he does not have any tax relief.

This can be viewed as a way of encouraging more employees to take up private pension schemes as opposed to relying on the legal and compulsory pension requirement by the government. But how do employees become tax savvy about their pension plans to ensure they get maximum payouts at the maturity of their schemes?

Here are some tips pension scheme members can put into consideration while making decisions about the money.

The first tip is to ensure that you complete paying your mortgage before retirement.

Your monthly payouts are tax free up to a certain amount. However, after the threshold the tax breaks do not apply. Mortgage is usually the biggest monthly bill, and if you can get rid of that during employment years you will have much more flexibility in retirement.

It is unfortunate that some people carry mortgages into their retirement.

It is difficult to minimise tax if you have to withdraw a large amount of money from your pension scheme to pay monthly bills.

You also need to reduce your expenses. How can reducing your expenses help with your taxes?

MODERATE EXPENSES

If you do not spend a lot of money every month, you will not have to withdraw as much from your retirement fund.

By keeping your expenses moderate, you will be able to stay under a favourable tax bracket and take advantage of relieves.

Avoid premature withdrawal from your pension savings. This applies for any change of employer.

For example, you can access 75 per cent of your pension while switching jobs.

However, depending on the years of the scheme and a bunch of other factors, this is taxable.

Withdrawing retirement savings within less than 15 years of saving in a scheme or when you are below 50 years of age results in higher tax payment.

If you are above 50 years or have saved in a scheme for more than 15 years, your money will be subjected to wider tax bans (tax paid by individual is less).

The trick here is to transfer the money to other schemes, or withdraw when you are above 50 years; the first option is tax free and in the latter less tax is paid.

In fact, withdrawing your pension at the age of 65 is tax free.

Finally, diversify your after-retirement income.

It is important to diversify your after-retirement income. Retirees can have income from the social security fund, pension, rentals, taxable brokerage accounts, tax-free Roth accounts, saving accounts, bonds and more.

These incomes can be fully taxed, taxed at the long-term capital gains rate, partially taxed (social security benefit) or not taxed at all.

Keeping your taxable income under the 15 per cent tax bracket will help you minimise the amount of tax you pay in the long-haul.

Give yourself more options by saving and investing in different options in your employment years.

There are other ways to lower your taxable income such as donating to charity and taking some investment losses.

However, keeping your expenses low after retirement is the key to minimising taxes.

If your annual expenses are low, you will not have to withdraw a lot from taxable accounts.

Work with your tax accountant or investment advisor to make sure you do not pay more taxes than you have to when you retire.

RUTH NJUGUNA, Manager, Pension Administration and Consulting, Enwealth Financial Services.