NEW tax arrangements may have a profound effect on how you save for retirement.
Last week, Finance Minister Pravin Gordhan
announced that from March 1 2012, employees will face a "fringe benefit tax" on company contributions to their pension and provident funds.
However, you will also then be able to deduct 22.5% of your income for contributions to pension, retirement annuity (RA) and provident funds. This means that you may get a lot more tax back if you hike your pension savings.
Currently only 7.5% of your pension fund contributions are tax deductible (along with a maximum of 20% contributed by your employer). If you invest in an RA only, 15% of your contributions are deducted. (If you contribute to both, a smaller portion of your RA contribution will be tax deductible.)
But while 22.5% of the contributions may be deducted, government is placing a cap of R200 000 per year on deductible retirement savings. Effectively this means that people earning more than an estimated R890 000 a year, and who already invest the maximum amount allowable under the current arrangement, will be worse off.
For the rest of us, the question will be how to maximise the tax advantage.
If you are a member of your employer's pension fund, you can simply hike your pension fund contribution to get the maximum tax benefit – without taking out or topping up an RA. It may make financial sense since there is no commission involved and costs may be cheaper, says Kobus Hanekom, executive consultant at Simeka Consultants & Actuaries.Provident funds could fall away
He expects self-employed people will dramatically hike their RA contributions to the maximum level of 22.5%.
In the past, many high earners may have invested excess cash, including their bonuses, in RAs – but from a tax viewpoint this is not as appealing any more, says Richard Carter, head of product development at Allan Gray.
But Carter believes that the low costs of some of the "new generation" RAs – which won't charge you penalties if you can't contribute – will help keep these vehicles popular, compared to other more pricey alternatives.
Provident funds, however, will probably become something of the past. The main attraction of provident funds – the fact that you can get a full cash payout when you retire – looks set to disappear. All future contributions will be subject to a maximum withdrawal of one-third, as is the case with pension funds and retirement annuities.
There won't be any advantage in investing in provident funds when that happens, says Carter.
Hanekom expects provident funds will effectively be turned into pension funds while preserving any historical lump sum benefits. Because of the fact that all existing lump sums will be protected, there is no reason for any member to resign or to take any measures to try and protect these lump sum payouts.