Does the tax­man help you save for re­tire­ment?

Tax-free sav­ings prod­ucts were in­tro­duced two years ago while re­tire­ment annuities – in some form or an­other – have been around for decades. How do they mea­sure up in terms of help­ing you to save for your golden years?

Finweek English Edition - - MARKET PLACE -

with the end of the tax year on 28 Fe­bru­ary, now is a good time to re­mind our­selves again of the nu­mer­ous ad­van­tages of sav­ing for re­tire­ment through cer­tain in­vest­ment prod­ucts. These in­vest­ment ve­hi­cles have con­sid­er­able tax ad­van­tages over dis­cre­tionary prod­ucts, where these ben­e­fits do not ap­ply.

Specif­i­cally, we’ll be look­ing at the good old re­tire­ment an­nu­ity and then also tax-free in­vest­ments, which were in­tro­duced in 2015 as an ad­di­tional sav­ings ve­hi­cle to en­cour­age South Africans to save more.

Re­tire­ment annuities (RAs)

RAs have been around for as long as most of us can re­mem­ber. They are ba­si­cally pri­vate pen­sion plans, specif­i­cally de­signed to help you save for re­tire­ment. They have evolved sig­nif­i­cantly over time into much more flex­i­ble and af­ford­able in­vest­ment ve­hi­cles from the more tra­di­tional life in­sur­ance prod­ucts of old.

In­vestors can now make use of so-called “new-gen­er­a­tion” RAs on linked in­vest­ments plat­forms (LISPs). These are more flex­i­ble and far less ex­pen­sive to ad­min­is­ter, con­tri­bu­tions can be made as and when the in­vestor chooses (in the form of a lump sum or a reg­u­lar debit or­der) with­out pos­si­bly pay­ing any penal­ties for miss­ing con­tri­bu­tions, and there are also a wealth of un­der­ly­ing unit trusts avail­able to choose from.

Ben­e­fits of sav­ing through an RA

The first and most sig­nif­i­cant ben­e­fit is the tax de­ductibil­ity of RA con­tri­bu­tions. As from 1 March 2016 all con­tri­bu­tions to pen­sion, prov­i­dent and RA funds are con­sol­i­dated and are de­ductible up to 27.5% of the greater of re­mu­ner­a­tion or tax­able in­come, capped to R350 000 an­nu­ally.

Graph 1 on page 23 gives an in­di­ca­tion of the amount an in­vestor can ex­pect to re­ceive as an an­nual re­fund, based on a spe­cific an­nual in­come. (As­sum­ing an an­nual con­tri­bu­tion rate of 15% of re­mu­ner­a­tion.)

But don’t go and spend that RA re­bate, it can con­sid­er­ably boost your re­tire­ment ben­e­fit. If we look at a prac­ti­cal ex­am­ple us­ing an in­di­vid­ual who earns an an­nual salary of R600 000, in­creas­ing at 6% per an­num, who starts con­tribut­ing to an RA at age 40, for a pe­riod of 25 years, the an­nual re­fund will be R33 897.

The monthly RA con­tri­bu­tion at a rate of 15% per an­num amounts to R7 500. As­sum­ing no change in tax brack­ets for pur­poses of slightly sim­pli­fy­ing the cal­cu­la­tion, an an­nual in­vest­ment growth rate of 10%, in­fla­tion rate of 6% and if the in­di­vid­ual then also rein­vests the an­nual re­fund from year 1 for a pe­riod of 24 years, the in­di­vid­ual would have saved an ad­di­tional R 2 864 031 (to­tal pro­ceeds of R11 549 735) at re­tire­ment.

To put the num­bers in per­spec­tive, it’s an in­crease in re­tire­ment sav­ings of 33% at age 65!

RAs also of­fer other tax ad­van­tages

The ben­e­fits of sav­ing through an RA don’t end there. With any dis­cre­tionary in­vest­ment, cap­i­tal gains tax is payable; not so with an RA. In­ter­est and div­i­dends are also not taxed in an RA, which means ba­si­cally all in­vest­ment growth is tax free, and this also adds up ex­po­nen­tially over the long term. We will have a closer look at an ex­am­ple of the im­pact of tax-free in­vest­ment growth when we dis­cuss tax-free in­vest­ments fur­ther down in this ar­ti­cle.

But, what the tax­man giveth, the tax­man will even­tu­ally taketh away. When you put up your feet one day when you re­tire, you will have to pay tax on the pro­ceeds taken in cash (you are al­lowed to take up to one third in cash at re­tire­ment, any time af­ter age 55). How­ever, lump-sum ben­e­fits are taxed on a favourable slid­ing scale with a por­tion of the ben­e­fit tax free. Be­cause you are de­fer­ring pay­ing tax on the pro­ceeds of your RA, there’s also a larger in­vest­ment amount that can grow and com­pound over time, all tax free.

The other two thirds of the pro­ceeds from your RA will be used to pur­chase an an­nu­ity, which will then be used to pro­vide you with an in­come dur­ing re­tire­ment. You will have to pay tax on your monthly “in­come” but once again, it will most prob­a­bly be at a lower

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