Differences between an RA and a tax-free account

CARLA Rossouw, a tax manager at Allan Gray, says the main differences between retirement annuities (RAs) and tax-free investments are:

• Retirement funds offer tax savings now. You pay less tax now because you make contributions with earnings on which you have not paid tax, but you will pay tax later when you exit the fund. In other words, you defer paying tax. In return, there are rigid legal restrictions on withdrawing your money.

• Tax-free savings investments offer lower tax savings and are capped at a lower contribution amount but are less restrictive – they allow you to take your money out at any time.

“RAs in most cases offer the best tax benefits, but they come with the most onerous conditions,” Rossouw says. “In addition to your contributions being tax-deductible (see main article), there is no tax on investment returns (interest, dividends and capital gains) while in the product. However, you are taxed on exit (when you withdraw money, retire or die), although the first R500 000 of your one-third cash lump sum is tax-free.”

The drawbacks are that you do not have access to your savings before the age of 55, and your investments are constrained by regulation 28 of the Pension Funds Act, which stipulates the maximum exposure you can have to certain asset classes.

By comparison, with tax-free investments, contributions are not tax-deductible. However, like RAs, there is no tax on interest, dividends or capital gains. “You can access your money at any time, although you are not able to replace what you have withdrawn, and you must be aware of contribution limits and associated penalties,” Rossouw says.