After-tax money to a pension fund?
PROS AND CONS OF GOING BEYOND R350 000 You need to make sure that you have enough liquidity on the outside.
Since March 2016 tax-deductible contributions to pension funds, provident funds and retirement annuities (RAs) have been capped at R350 000 (or 27.5%) per annum.
While high-net-worth individuals (HNWIs) who previously contributed over R350 000 to these vehicles may continue to do so, excess contributions will be made with after-tax money and their take-home pay will reduce.
So does it still make sense for HNWIs to contribute over R350 000 p.a. to a retirement vehicle if they lose the upfront tax benefit or should they rather use discretionary investments?
Wouter Fourie of Ascor Independent Wealth Managers said it’s important to assess a person’s overall financial situation.
In retirement, liquidity’s very 1 important and one must determine if investors have sufficient funds outside a retirement vehicle, he stressed.
People who contribute to a RA or pension fund may only withdraw one-third of the money as a lump sum at retirement. The first R500 000 will be tax free. The remaining two thirds must be annuitised.
“You need to make sure that you have got enough liquidity on the outside. So it does not benefit me to have all my savings in this retirement fund if I exceed the cap and I don’t have any external money available.”
In terms of Regulation 28 of the Pension Funds Act, retirement funds can’t invest more than 75% of the funds in equities, and 25% offshore.
Investors who need more offshore exposure would be able to go beyond the Regulation 28 limits in a discretionary investment and would also have the benefit of liquidity.
But, if an individual has sufficient liquidity in his portfolio, returns on pension fund contributions are allowed to grow free of tax while inside the fund, so growth would be better than in a normal unit trust structure, Fourie said.
Jenny Gordon at Alexander Forbes said in 2014 a new section 10C was introduced into the Income Tax Act.
“If you make an after-tax contribution to a fund, when you start drawing an annuity you can actually now set off that after-tax contribution against compulsory annuity income so that you actually don’t lose it.”
Gordon said a lot of high-income earners enjoyed using this provision.
“They find that during their [first] couple of years into retirement when their income tax is still quite high, they actually are able to completely write-off from tax the full amount of their compulsory annuity income.”
Ronald King at PSG Wealth said there are a number of reasons why he’d definitely consider contributing over R350 000 per annum.
The first R500 000 will be tax free.