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Picture: 123RF
Picture: 123RF

The approaching end of the tax year is a perfect opportunity to focus on the benefits of using a retirement annuity to maximise tax breaks. 

Different types of retirement vehicles

Pension or provident funds are company-linked retirement vehicles that form part of your employment agreement with your employer. In SA, a company pension or provident fund is not mandatory. Most companies offer them but some don’t.

A retirement annuity is a useful option for individuals who are not pension or provident fund members — self-employed individuals or those who don’t have company-linked pension or provident fund.

But people can have retirement annuities and also be members of pension or provident funds at the same time. 

The common thread of all these vehicles is that they are tax-efficient ways of saving for retirement. You qualify for tax savings on funds you invest in accumulating investment capital through monthly pay deductions, regular debit orders or ad hoc lump sums.

How to reduce your tax bill

The allowable annual tax deduction on funds invested is limited to 27.5% of taxable income (capped at R350,000 a tax year).

For example, an individual earning R1m a year (putting them in the 41% marginal tax bracket) qualifies for tax-deductible contributions of R275,000 yearly. The result of this is an impressive tax saving of R112,750. This is a compelling reason to maximise retirement vehicle contributions.

For employers with with company-linked pensions or provident funds you need to ask your employer if the fund rules allow additional contributions to enable you to maximise your contribution for the year. If the pension or provident fund does not allow additional contributions, you would need to open a retirement annuity to account for the deficit.

Other tax benefits when using an RA

Retirement vehicles are also great estate planning tools in that you can nominate beneficiaries to receive the proceeds of your retirement savings when you die. Your appointed beneficiaries do not have to wait for your estate to be wound up (which could take up to 18 months) before receiving the funds, making retirement annuities a quick, efficient way of moving capital to loved ones.

Another benefit is that retirement vehicles are not estate dutiable, saving you up to 25% on estate duty. The present estate duty rate in SA is 20% on the first R30m and 25% on assets valued at more than R30m. No capital gains tax or income tax is payable on assets held in retirement vehicles.

So what’s the catch?

Based on the above, retirement vehicles seem a no-brainer, so why do some investors (as well as financial advisers) avoid using them? Here are some of the reasons:

  • Liquidity constraints on retirement annuities — any funds invested into retirement annuities can be accessed only from age 55 onwards. Pension and provident funds are accessible before age 55, but are heavily penalised through a withdrawal tax. New legislation taking effect on March 1 this year will introduce a “two-pot” system. This changes the rules that will govern accessibility to retirement capital.
  • Tax on cash lump sums — when you reach age 55 you are able to withdraw a maximum of a third as a cash lump sum and the first R550,000 is tax free. Thereafter tax is payable based on a sliding scale.
  • Regulation 28 — this is legislation that prescribes exactly how the assets can be invested in your retirement vehicle, namely a maximum of 75% in equities, a maximum of 25% in property, and a maximum 45% invested offshore.

Domestic retirement vehicle, or offshore?

Probably the most common question we encounter is: how much should one be investing offshore? Investment markets, locally and globally, have been in a state of flux — up one moment, and down the next. This has left many investors in a state of limbo, not knowing whether to enter or exit the market.

Given that the rand is weaker than it was a few years ago, one of the most notable areas of procrastination is whether investors should invest some of their funds offshore.

Does it still make sense to invest offshore if our rands buy substantially less hard currency than a few years ago? Most definitely, provided it is done for the right reasons and forms part of a long-term financial plan.

There is no single answer that fits all scenarios. My advice is to get advice from an independent, fee-based certified financial planner focused on your best interests.

He or she must be able to advise you on your optimal offshore exposure while also considering the attractive tax savings offered locally through retirement products, having taken into account your overall financial position and your overall asset and regional allocation.

• Botha is a certified financial planner & wealth manager at Netto Invest.

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