While you need to consider the impact of tax when planning your retirement saving strategy, it shouldn’t be yourprimaryconcern. Tax is certain, and there’s no avoiding it. That said, it needs to be factored in both while saving for retirement, and also during retirement, given the different tax treatment of those two scenarios.
Broadly speaking, the taxation process can be summed up as “exempt-exempt-tax”, consistent with regulations in many countries globally. You areexemptfrom tax on contributions made while saving for retirement (up to certain limits), you areexemptfrom gains on the investment(s) while you are saving, but you are subject toincome taxupon retirement as you draw down your savings.
Retirement savings vehicles
The key retirement-savings vehicles are Retirement Annuities and pension or provident funds. The main difference between these products is that the latter are employer-provided and are typically mandated in most large businesses. Retirement Annuities are typically used by self-employed individuals, employees in organisations that don’t offer a pension or provident fund, and those who want to increase their retirement savings.
The main benefits of retirement annuities are that you are able to contribute to as many of them as you wish, you can stop contributing whenever you want, and they are transferable. There is additional flexibility in that single-premium retirement annuities are available. This is a tax-efficient way to house any excess savings, as you are able to use the lump-sum amount to reduce your income-tax liability in that year.
The new Taxation Laws Amendment Act
The signing into law of the Taxation Laws Amendment Act (2015) and Tax Administration Laws Amendment Act (2015) by President Jacob Zuma, came into effect in March 2016 and has promted many questions from those who are saving for retirement via Retirement Annuities, pensions or provident funds.
In short, the act ensures that the tax benefits of contributions to provident funds, pension funds and Retirement Annuities are now on an equal footing. (See our Q&A for more detail on how the new act will affect you.)
It is also important to note that most people currently saving for retirement will be unaffected or better off under the changes. High-income earners are likely to be the most affected by the changes.
How the act affects you: Before retirement
The tax deduction increases from 15% of non-retirement funding income to 27.5% of the higher of remuneration or taxable income, up to a maximum of R350 000 annually, on contributions made towards structured retirement savings. This deduction now applies across the board, i.e. to provident fund contributions, pension fund contributions and retirement annuity fund contributions.
The distinction between retirement funding and non-retirement funding income has also been removed. That means all clients who were members of a pension/provident fund, and therefore unable to benefit further from the deductibility of contributions to a retirement annuity since their income was defined as retirement funding income, can now “top up” to the limit of 27.5% as described in the paragraph above.
How the act affects you: After retirement
In simple terms, without considering retirement fund lump sum withdrawal benefits, retirement fund lump sum benefits, or severance benefits received or accrued to an individual, any lump sum withdrawn at retirement above a minimum threshold (currently R500 000) is taxable. The table below illustrates the taxation applicable:
How is your annuity taxed?
The remaining two-thirds of your savings received in the form of an annuity (“pension”) is taxable. But this would only be for the amounts that exceed certain thresholds published by the South African Revenue Service. For the current tax year (to end-February 2017, these thresholds are:
- Under 65: R75 000 per annum
- Between 65 and 74: R116 150 per annum
- 75 and above: R129 850 per annum
Are early withdrawls still possible?
The withdrawal of the entire amount of a pension or provident fund is still possiblebeforeretirement, although this is in many instances very ill-advised due to the adverse tax consequences for the withdrawing individual. (For retirement annuity funds, withdrawals are only possible on early retirement due to ill-health or on emigration.)
Tax-free savings accounts
Lastly, tax-free savings account (TFSA) are another element those saving for retirement need to consider. The TFSA structure, introduced last year, offers an interesting way to supplement structured retirement savings. It would be difficult to argue that a TFSA is an absolute alternative to products like Retirement Annuities and pension funds. TFSAs allow the investment of R30 000 a year (up to a lifetime limit of R500 000, likely to be revised upward in future). These investments can be made in a number of different asset classes and all gains on these investments (capital gains, dividends and interest) are completely tax-free.
However, contributions are not tax deductible, which is why TFSAs should only be considered as a way to supplement whatever retirement savings an individual already has, especially if they are at (or near) the contribution limit of 27.5% of the higher of remuneration or taxable income.
With so many complex factors to consider and a very long time horizon, it is critical to get professional investment advice for your retirement saving, as well as the tax impact of choices you will need to make.
For more information on investing for retirement, speak to your financial adviser.
This article is part of an investment series by Discovery Invest. Click here to read the rest of the articles.
