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Retirement and tax: What you need to know

Apr 12 2016 13:09


Cape Town - You need to consider the impact of tax when planning for your retirement, but it shouldn’t be your primary concern. That said, you should factor this in when saving for retirement, and also during retirement, given that tax is treated differently before and after retirement.

Broadly speaking, the taxation process can be summed up as “exempt-exempt-tax”, consistent with regulations in many countries globally.

You are exempt from tax on contributions made while saving for retirement (up to certain limits), you are exempt from gains on the investment(s) while you are saving, but you are subject to income tax upon retirement as you draw an income (annuity) from your retirement 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, over and above their pension and provident fund.

You can contribute to as many retirement annuities as you wish and they are transferable. 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

President Jacob Zuma has signed the Taxation Laws Amendment Act (2015) into law, and it came into effect on 1 March 2016. This has prompted 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.

It is also important to note that most people currently saving for retirement will be unaffected or better off under the changes.

How the Act may affect you: At retirement

For now annuitisation for Provident fund members has been delayed for two years until the 1 March 2018.

Annuitisation means members are able to withdraw up to one third of their retirement annuity or pension/provident fund savings as a cash lump sum at retirement and the remainder (two-thirds) must be used to purchase an annuity i.e. income in retirement.

The tax deduction increases from 15% to 27.5% of taxable income on retirement annuities and pension and provident funds (up to a maximum limit of R350 000 annually).

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 claim a tax deduction for the contributions they made to a retirement annuity can now “top up” to a retirement annuity up to the limit of 27.5%.

How the Act may affect you: After retirement

Any cash lump-sum withdrawn at retirement above the minimum threshold (currently R500 000) is taxable. Between R500 000 and R700 000, the tax rate is 18%; between R700 000 and R1050 000 it is 27% and over R1050 000, it is 36%.

Tax on your annuity

The remaining two-thirds of your savings received in the form of an annuity (“retirement income”) is taxable. This would only apply to amounts that exceed certain thresholds published by the South African Revenue Service (SARS). For the current tax year (to end-February 2016), these thresholds are:

• Under 65: R73 650 per annum

• Between 65 and 74: R114 800 per annum

• 75 and above: R128 500 per annum

Early withdrawals from pension funds

The new Act does not apply if you leave a provident or pension fund before retirement, either because of changing jobs, retrenchment or dismissal.

Also, the withdrawal of the entire amount of a pension, provident or preservation fund is still possible before retirement, although this is very ill-advised (For retirement annuities, withdrawals are only possible on early retirement due to ill-health or on emigration.)

Tax-free savings accounts

Lastly, tax-free savings accounts (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 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, speak to your financial adviser.

This article is part of an investment series by Discovery Invest.

How to play retirement catch-up
My story: How I’m saving for retirement
What will you do with your retirement?
5 gorgeous places that will make you want to retire overseas
Investment solutions for realities facing pensioners in retirement
My retirement savings story
Retirement products: What you need to know
Life changes, so should your retirement

Discovery Invest is an authorised financial services provider. Registration number 2007/005969/07. For more information on Discovery Invest, contact your financial adviser.

This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell investment funds.

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