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There is a big focus on the tax-deductibility of pension fund/retirement annuity (RA) contributions over the course of your working life. But what happens tax-wise when you reach retirement?
The tax-deductibility is an important incentive for people to provide for their retirement. It can be a significant incentive for people earning more than R188 000 per annum, as they can get as much as R28 back for every R100 invested. They then get growth in their pension fund/RA on the R100 invested.
At retirement they can access these funds either in the form of a lump, an income, or a combination of the two. If the investor takes a lump sum at the point of retirement, that lump sum will be subject to the retirement tax tables. With the retirement tax tables, the first R500 000 is tax free and the remainder is taxed on a sliding scale. If the retiree has withdrawn funds before this (post October 2007) such withdrawals are added to the current withdrawal when calculating the tax. This means that previous withdrawals may reduce the tax-free portion that the retiree receives. There is a difference in how much of the pot the retiree is able to withdraw; they can withdraw a third from pension funds and retirement annuities, and up to the full amount from the provident fund. Such withdrawals are subject to the same tax treatment though.
Whatever income the retiree takes from this pot is subject to income tax. Retirees qualify for higher rebates from age 65, which has the effect of reducing their effective tax rate. A higher rebate applies from age 75. All income from a retirement income product is subject to income tax, irrespective of where those funds originated from – whether from provident funds, pension funds or RA funds. Funds in the retirement income product grow tax free, but the income is taxed.
As a retiree, how can you minimise the impact of tax on your earnings?
A proper retirement plan takes into account the tax efficiency of the retiree’s income long before they reach retirement age. All income from a retirement income product (living annuity or a guaranteed annuity) is subject to income tax. A retiree earning over R9 680 a month could benefit from some tax planning. However, this requires that the retiree has some discretionary capital, and not all their retirement monies are invested in retirement products.
To mitigate tax, the retiree has a few options:
Make use of all tax exemptions (the interest exemption is R34 500 per annum for persons over 65. (Capital Gains Tax annual exemption is R40 000);
- Use tax-exempt products (like tax-free savings accounts);
- Earn dividend income (currently taxed at 15%);
- Consider tax-efficient funds (such as those offered by Sanlam and Prescient);
- Take some income from capital drawdowns (to access exemption and lower tax rates – the maximum rate is 16.4%); and
- Those who earn really high incomes could invest a portion of their funds into an endowment as returns are taxed in the endowment at a lower rate than in the hands of the investor.
In order to achieve a high level of tax efficiency, an investor needs to plan long in advance of retirement. This will ensure that they have a large enough capital amount in the tax-free savings account, and long enough exposure to dividend-yielding equity for the income to be at a meaningful level.
Craig Gradidge is co-founder of Gradidge-Mahura Investments.
This is part four of the cover story that originally appeared in the 10 November edition of finweek. Buy and download the magazine here.
