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Investments are critical to the lifestyles and well-being of most of us, but we often find ourselves lost and confused. One of the reasons for this is that the financial services industry has sown confusion with a vast array of investment products that are frequently sold indiscriminately.
Now imagine an investment
- where the contributions to the investment are tax deductible*;
- where no tax is paid on the growth obtained on the funds in the investment;
- where the investment does not form part of your estate and no estate duty tax is payable on the investment or the growth on the investment; and
- where the investment and investment returns are protected from your creditors.
Best of all is that all of this is guaranteed!*
*Subject to the Income Tax Act.
I am talking about investment in retirement funds.These investments in pension funds, provident funds and retirement annuities are, once you strip away the marketing clutter, the best investment your money can buy.
From 1 March 2016 the total contributions to retirement funds (pension, provident and retirement annuity) are tax deductible but limited to 27.5% of the greater of remuneration or taxable income, capped at an annual limit of R350 000. The taxable income used in these calculations excludes lump sums, and any excess not utilised in calculating the deductible amount, may be carried forward to the following tax year. This means that for every R1 you invest for your own future income, Sars will refund you an amount equal to your current marginal tax rate, which is between 18% and 41%.
Paying yourself first
It is best explained by an example: If your marginal tax rate is 30%, you will receive 30c from Sars for every R1 you invest in your retirement fund. That means you get R1 invested for your future and only pay 70c for it. Using a simple equation (30/70*100) it means an effective return on investment of 42.85% – guaranteed! It also means that the higher your marginal tax rate, the bigger your guaranteed return. (See table 1 below.)
But remember that your retirement fund (pension, provident and retirement annuity) is the “vehicle” used to obtain the tax benefit. You can benefit even more when you choose the “engine” that will provide the investment returns. A well-diversified balanced portfolio will, over the long term, provide inflation-beating returns. So, growth at a rate better than inflation, combined with the added tax benefits, makes this possibly the best investment you will ever make. (See table 2 below.)
On retirement, which per tax laws is at 55 and older, you will qualify to receive the first R500 000 of your retirement fund tax free and the remainder of your monthly income will be taxed at your average tax rate, which is, by the time you retire, much lower than before retirement.
So even if your investment returns end up to be zero for the full term, which is highly unlikely, then the tax benefit alone makes it a no-brainer. To get the most benefit, you must use the full tax-deductible contribution to your retirement funds. This will also assist in providing you with an income at retirement. This practice is often referred to as “paying yourself first”. It is never too late to start investing in your own retirement fund.
28 February marks the deadline for topping up your retirement funds for this tax year. Don’t miss out on this opportunity!
In the next edition, we’ll look at which retirement annuity (the vehicle) – traditional versus new generation – to use, and how to choose the investment fund (the engine).
Wouter Fourie is a director of Ascor Independent Wealth Managers and the Financial Planning Institute of SA (FPI). He is an award-winning certified financial planner.
This article originally appeared in the 2 February edition of finweek. Buy and download the magazine here.
