‘Cheat’ tax and retire gracefully

One of the best ways to make a small sacrifice now for a big benefit later is to use a “free deal” from the taxman.

It involves contributing to a retirement fund, and re-investing the tax saving you get back from the South African Revenue Service (Sars) in a retirement annuity.

One of the main criticisms of retirement annuities (RAs) is that you will eventually have to pay tax on the money saved in the RA. If you invest more than R1 000 a month into an RA now and increase the contributions yearly with inflation for 35 years, this will probably be the case.

When you invest in an RA, you are deferring tax. The benefit of deferring tax is that you give your capital more time to grow so that the tax is effectively paid by capital growth.

If you were to invest the tax saving from Sars into an investment vehicle such as a tax-free savings investment, it allows you to build up an amount which you will be able to access as additional tax-free income when you are older.

Let’s consider two scenarios – one where you don’t re-invest the tax saving, and one where you do.

In both instances, you start by putting R4 500 a month into a retirement annuity, and in both instances you want to draw the equivalent of R20 000 a month in today’s terms from age 65 onwards (increasing each year in line with inflation).

With the second scenario, we deduct 5% per month (effective tax rate on non-retirement income; for assumed interest tax and possible capital gains tax) but – importantly – save an additional amount each month by re-investing the tax saving from Sars into a flexible investment.

Where you don’t re-invest the tax saving from Sars on your retirement fund contributions – by age 84, the income required will exceed the amount the investments will be able to provide.

Where you do re-invest the tax saving from Sars on your retirement fund contributions the income provided should last to age 99.

The difference that effective and tax-efficient saving can make to your life is astounding.

Christiaan Bekker is a certified financial planner at Verso Wealth.