Why pay the taxman more than his fair share if you can boost your retirement savings and enjoy tax benefits to boot?
This is the argument for making the most of your tax deductions for contributions to a retirement fund and tax limits for a tax-free savings account before the end of February.
Both tax-free investment accounts and retirement annuities allow you to grow your savings tax free, meaning there is no tax on the interest, dividends, income or capital gains payable on the investment growth, says Jaco Prinsloo, a certified financial planner at Alexander Forbes.
But, he adds, the tax implications on contributions and withdrawals of the two are quite different.
Natalie Kiewitt, operations executive at PPS Investments, says both a retirement annuity fund and a tax-free investment account offer tax-efficient ways to save for your retirement.
Investors and advisers have raised concerns about the investment rules for retirement funds, which say you can only allocate 30% to offshore markets - the rest must be invested in the local share, bond or cash markets.
Recently, the local economy has been struggling and returns from local shares have been low.
In addition, some South Africans are concerned about ploughing more money into retirement savings as the possibility of retirement funds being obliged to invest in certain prescribed assets is being discussed by the ANC, says Prof Deborah Tickle, a tax lecturer at the University of Cape Town.
Though it is only an idea mooted by the ANC at this stage, with no further details available, if implemented prescribed assets could force retirement funds to invest a portion of their money in designated investments, which may include state-owned enterprises and other projects, with potential implications for returns.
But since it is not clear if this will come about or whether the limit on offshore investments will hamper future returns, you may still benefit from boosting your retirement savings with a tax-deductible contribution to a retirement annuity - or your employer-sponsored fund if it allows ad hoc contributions - before the end of February.
Your contributions to all your retirement funds are only tax deductible up to a point, though only high earners typically have enough to reach these maximums (see "how to calculate what you can deduct from tax" below).
If you are concerned about the possible introduction of prescribed assets on retirement funds, you can still enjoy a benefit by saving into a tax-free investment account, but you will not get a tax deduction for amounts you put in these accounts.
Kiewitt says while a tax-free investment account is not designed to be your sole source of retirement savings, it gives you an opportunity to boost your nest egg with a lump sum.
"The money you save in a retirement annuity is protected from creditors and saves you estate duty" Jaco Prinsloo, a certified financial planner at Alexander Forbes
You can invest up to [R36,000] each tax year until you reach the lifetime contribution limit of R500,000 in a tax-free investment account. The advantages are that you do not pay tax on the investment income or growth and neither do you pay dividend-withholding tax, she says. It is important that you don't exceed the [R36,000] a year as any excess will be taxed at 40%.
Prinsloo agrees that retirement annuities and tax-free investment accounts offer tax efficient ways to save.
While there is no tax saving on the contributions you make to a tax-free investment account, you can withdraw your savings as a lump sum or a monthly income free of tax, he says.
There is no minimum investment period, but any money withdrawn from a tax-free savings account cannot be replaced and it permanently reduces your [R36,000] annual and R500,000 lifetime limits, he says.
Which is the better option?
Prinsloo says if you are paying tax on your income, are comfortable with the investment restrictions in regulation 28 of the Pension Funds Act, and can afford to keep your money invested until at least the age of 55, investing in a retirement annuity may be the better option because of the tax deduction you enjoy for any contributions you make.
Apart from the tax deduction on retirement annuity fund contributions, the money you save in an retirement annuity is also protected from creditors and saves you estate duty as your savings are distributed directly to your dependants and/or nominated beneficiaries identified by the trustees of the fund, he says.
Any amounts for which you did not get a tax deduction after March 1 2015 will qualify for a deduction in your estate.
If you want to increase your exposure to global markets by, for example, investing more in global equities or if you want access to your funds, a tax-free investment account may be the better option due to the flexibility the investment offers.
The choice will depend on your circumstances and your investment goals, and consulting a qualified financial adviser may help guide you, Prinsloo says.
How to calculate the tax deduction for a retirement fund contribution
When you calculate the tax deduction you will enjoy when you pay into a retirement fund such as a retirement annuity, remember you can contribute as much as you like, but the tax deduction you enjoy is limited to the lowest of three amounts.
This limit relates to all your retirement fund contributions - to your pension, provident or retirement annuity funds, and includes any contributions made by your employer to any fund on your behalf.
- The first of the three limits is a maximum overall deduction of R350,000.
- The second amount is calculated based on 27.5% of the higher of two alternative amounts:
- The first of the two is your remuneration (salary and benefits) but not including any lump sums you may have on resignation withdrawn from, or on retirement been paid by, your retirement fund, as well as any severance benefits you may have received on retrenchment.
- The second amount to which you can apply 27.5% is your taxable income (all your income that is subject to tax less any allowable deductions). This must also not include any lump sums withdrawn or paid from your retirement fund or any severance benefits. It must also exclude any donations to public benefit organisations that are tax deductible (you need an s18A certificate to be able to deduct). You must also exclude any foreign taxes you may have paid.
- The last (third) calculation you need to do is to take your taxable income, again excluding retirement fund lump sums or withdrawals and/or severance benefits, and also exclude any capital gains. This calculation should also exclude deductions for donations to a public benefit organisation and foreign taxes.
Once you've calculated these amounts, the lowest of them is the maximum tax deduction you can enjoy for contributions to any retirement fund in any tax year.
You can then work out how much you have contributed so far, and if you can contribute more, do so before the end of the tax year to maximise your tax benefit.
If you make a mistake and contribute too much to the funds, the SA Revenue Service will record the excess amount on your assessment and carry it forward to the next tax year. If you contributed more than was allowed the previous year, be sure you take this into account this year.
Please note: as of March 2020, the tax free savings threshold has increased from R33 000 to R36 000.
This article was published on the Business Live Website on 18 February 2020.