(i) Contribution to retirement schemes
An individual’s contribution to a registered pension or provident fund is an allowable deduction against the taxable income. The deductible amount is the actual contribution made by the employee to the scheme(s) but must not exceed 30% of pensionable pay or Sh. 20,000 per month. Take for instance if an employee earns a basic salary of Sh. 100,000 per month and contributes Sh. 10,000 to a registered pension scheme, the taxable income shall be Sh. 90,000. This brings some tax savings to contributors.
Majority of contributors to retirement schemes are employees, however the law does not limit the tax incentive above to employees only. Individuals under self-employment or employees who consider their employers’ schemes inadequate are allowed to save through individual retirement funds. The tax saving illustrated above still applies provided the Individual retirement scheme is registered. A good example of a savings plan for self-employed individuals is the Mbao savings plan by retirement benefits authority which allows members of the informal sector to save as little as Sh. 20 per day.
Another benefit of saving through retirement schemes is that the contribution made by the employer on behalf of employees is a non-taxable benefit to the employee. This applies regardless of whether the scheme is registered or not. However, employees working for organizations not subject to tax are taxed on the employer’s contributions to unregistered schemes or amounts in excess of Sh. 20,000 per month contributed to registered schemes. (Ref ITA Sec 5(4) c)
(ii) Retirement benefit
Pension benefit upon retirement may be paid in form of annuities or in lump sum. Where the retirement benefits are paid in form of annuities the first Sh. 300,000 per annum (Sh. 25,000) is exempted from taxation.
Where the pension benefit is paid in lump sum, the exempt amount shall be the lower of:
Ø Ksh.600,000; or
Ø Ksh. 60,000 X number of years of service in that employment if less than ten years.
Withdrawals made in lump sum by retirees above the age of fifty years or retirees who have contributed to the scheme for more than fifteen years or persons retiring due to Ill health or infirmity in body or mind are taxed in bands of Sh. 400,000.
Pension lump sum for early retirees below the age of fifty years and not meeting the conditions outlined above is taxed under the individual scale rate of tax.
Consider the following illustration for two taxpayers, one retiring at 53 years and the other at 48 years. All receive the same amount Sh. 2,400,000 as lump sum pension payment.
| 53 YEAR OLD | |||
| AMOUNT RECIEVED | 2,400,000 | ||
| EXEMPT AMOUNT | 600,000 | ||
| TAXABLE AMOUNT | 1,800,000 | ||
| TAXED AS FOLLOWS | Tax Band | Tax Rate | Tax |
| First | 400,000 | 10% | 40000 |
| Next | 400,000 | 15% | 60000 |
| Next | 400,000 | 20% | 80000 |
| Next | 400,000 | 25% | 100000 |
| 1,600,000 | |||
| rest | 200,000 | 30% | 60000 |
| Gross tax | 340000 | ||
| 48 YEAR OLD | |||
| AMOUNT RECIEVED | 2,400,000 | ||
| EXEMPT AMOUNT | 600,000 | ||
| TAXABLE AMOUNT | 1,800,000 | ||
| TAXED AS FOLLOWS | Tax band | Tax rate | Tax |
| FIRST | 288,000 | 10% | 28800 |
| NEXT | 100,000 | 25% | 25000 |
| REST | 1,412,000 | 30% | 423600 |
| GROSS TAX | 477400 |
The tax so deducted shall be final tax.
The illustration above demonstrates that early retirees suffer more tax. It’s advisable for individuals changing jobs to consider moving their pension benefit from one scheme to another rather than making an early withdrawal and suffer heavy taxes.
Pension income received by retirees above the age of 65 years is exempted from tax.
Upon death of a contributor, where the registered fund provides for no payment of retirement benefits other than the payment of a lump sum to an estate, the first one million four hundred thousand shillings of such a lump sum payment to the beneficiaries shall be exempted from tax. (Ref: ITA Sec 8(6))
Note: Pension withdrawals from unregistered pension fund is not subject to tax