YOUR MONEY: How your retirement vehicle can work for you

Question:

What is the difference between a retirement annuity, a pension fund and provident fund, and what are the benefits of each?

— Richard M

Answer:

There have been many changes to retirement products over the past few years. There was the annuitisation of provident funds in 2021 — essentially making them similar to pension funds (which I will explain below). Legislation around the two-pot retirement system, proposed to take effect from September 1, will further change the rules on all of these products.

Where we stand today, an employer or company group normally offers a pension or provident fund, whereas a retirement annuity is more typically structured as an investment for an individual. You are allowed to have a combination of these products.

• You are allowed to invest up to 27.5% of your annual taxable income into these products, and deduct these contributions from annual tax payable up to a maximum of R350,000 a year.
• Anything invested over and above your 27.5% or R350,000 annual allowed deduction will be seen as a “disallowed contribution”. This means this excess contribution cannot be used as a tax deduction currently, but you can start building up a pool that can be used at retirement (after the age of 55), when you can offset this lump sum against your living annuity — and offset income tax payable. At this stage your retirement vehicles will be converted into a living annuity, earning an income of between 2.5% and 17.5% of fund value taxed on the income tax scale. The lump sum accumulated can then be offset against your income tax annually until it is depleted, whereafter normal income tax scales will apply again.
• Growth within the vehicle is not taxed.
• You are allowed to nominate beneficiaries on these products, which means they are excellent estate planning vehicles.
• Any pre-retirement vehicle — and this includes not only retirement annuities, pension funds and provident funds but also preservation funds — is subject to regulation 28. There are a few rules that determine how the funds are invested, the most common topic being the offshore limit. This was previously limited to 30% but has been increased to 45%. Once you’re retired and restructuring towards a living annuity, these regulations fall away.
• At the age of 55 you are allowed to access one-third of your portfolio (the first R550,000 will be tax-free) and a sliding scale applies further. The remaining two-thirds will pay out monthly, and income tax will be payable on this income earned. Keep in mind the R550,000 can vary depending on whether any funds are owed to the South African Revenue Service, previous withdrawals or any retrenchment package taken.
• On resignation, you can access your pension or provident fund, though a painful tax sliding scale applies. Instead of following this route, we will always recommend reinvesting your funds in your private capacity when changing employers, as starting over every time will erode your future savings and make sufficient retirement provision impossible.

I think retirement vehicles are incredible tax-optimisation tools which can be enhanced even further by using the information provided in my second point above, essentially creating a tax-free retirement for many years. This is also a fantastic estate planning approach, as you can be sure these funds will be allocated to loved ones immediately on your passing and not go to your estate.

The proposed two-pot system changes the rules significantly, and will be elaborated on in future articles.

— Elke Brink, wealth adviser at R21 Wealth Management, Stellenbosch

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