By Eugene Maree, MD at Wealthport
Winner of the Best Linked Investment Service Provider (LISP) and Best Technology Platform Award for 2017 at the 2nd Annual Africa Structured Products and Alternative Investments Awards
1. How much tax can someone expect to pay on their retirement annuity? Please use one or two examples to illustrate this.
You receive a tax deduction on your contributions towards a Retirement Annuity. Also retirement funds fall outside of your estate, so at death you won’t need to pay estate duty, which is between 20% and 25% depending on the size of your estate.
Further to this, a Retirement Annuity is not subject to Capital Gains Tax (CGT) or Dividends Withholding Tax (DWT). In addition to this, Section 10c of the Income Tax Act makes provision for disallowed contributions to be taken as a tax free income or lump sum at retirement. Therefore, Disallowed Contributions (anything above the cap of R 350 000,00) that have not been taken out become part of your estate when you are no longer around.
In simple terms the tax man gives you a tax break to encourage you to save for your retirement by giving you the tax back on the portion you save up to a max of R350 000. However, they then have to get the tax back at some point and then tax you when you take it out your pension or retirement annuity (see table below). If you choose to draw an income your income will be taxed at your marginal rate at retirement which hopefully is at a lower rate than when you were working. In the event that you contributed more than the maximum amount of R350 000,, then you don’t get the tax back on that portion but you can withdraw tax free on retirement as you have already received the tax on that portion as it was considered ‘after tax income’.
Please refer to example below for an example on this works:
| Taxable income from lump sum benefits
|| Rates of tax
| R 0 – 500 000
|| 0% of taxable income
| R 500 001 - 700 000
|| 18% of taxable income above R 500 000
| R 700 001 – 1 050 000
|| R 36 000 + 27% of taxable income above R700 000
| R 1 050 001 and above
|| R 130 500 + 36% of taxable income above R 1 050 000
X received a lump sum of R682 000 from the ABC Pension Fund, and had received no previous lumps sums prior to this. Over a number of years, the total contributions which did not previously rank for deduction or qualify for exemption in X’s hands amounted to R50 000. Calculate the normal tax payable on this lump sum.
The gross lump sum on which normal tax will be calculated amounts to R682 000 less R50 000, which e equals R632 000. R632 000 falls within the taxable income bracket of R500 001 to R700 000. The normal tax is therefore 18% of the taxable income above R500 000. Thus:
= 18% of (R632 000 - R500 000)
= 18% of R132 000
= R23 760
The normal tax on the lump sum of R682 000 therefore amounts to R23 760, and the net lump sum after tax (“cash in pocket”) would equal R658 240.
2. Is there any way to reduce the amount of tax someone will have to pay on their retirement annuity? In other words, can you keep your retirement savings in another form so that you lose less to taxation? What else can be done?
The only way a client can be tax efficient is by paying the least amount of tax, however, as you know one cannot avoid taxes given it is considered a criminal act. So, when contributing to a Retirement Annuity, a client needs to be cognisant that they will only have access to their funds at retirement (age 55) or through formal immigration or mental incapacity. They should also take into consideration that their contributions are capped at 27, 5% of gross remuneration with a maximum of R 350 000, 00 pa.
In addition, clients can invest in an alternative investment vehicle such as a Tax Free savings account. However, while the limit per annum is small (R33 000) and the maximum amount allowed over your life time is R500 000 the compounding effects of tax savings go a long way to enhancing the clients’ return thereby boosting their retirement capital. If you want to save in additional products that offer tax breaks you need to take into account that different savings products are taxed differently. For example; cash is taxed as income while equity investments are taxed as capital gains. So it’s important to get good independent advice as a good independent advisor who will be able to help you optimise your portfolio to make it as tax efficient as possible.
3. Why are retirement funds taxed in the first place? Are there countries where citizens are exempt from this type of tax?
When you finally retire from your Retirement Annuity and transfer these funds into a Living Annuity, the income you receive will be taxed at your marginal tax rate. However, with solid financial planning, you can manage the amount of tax you pay, and as mentioned earlier, if you contribute more than the R350 000 annual cap, you can draw this amount as tax free income in your retirement. If you pass away before drawing this income, only that portion will go back into your estate and be dutiable.
Yes, there are countries that have no income tax which is why many wealthy people emigrate to them including:
- The Bahamas
- British Virgin Isles
- Cayman Islands
- United Arab Emirates (Dubai)
- Turks and Caicos
In addition to no income tax countries there are also some more very low tax countries including Malta, Malaysia and Panama for example.
4. What are your top tips to someone who would like to start saving for their retirement? You’re welcome to answer this in bullet point form.
- The easiest is… Just start! Even if just small. (Sounds easier said than done as there is always something else you want to buy). So, get into the habit of investing first and spending after- not the other way around.
- The earlier the better. The compounding effects are magical and the longer you have the greater the magic!
- Watch out for fees. (You want to compound growth not costs). Every % point in fees reduces the growth you’re compounding. Good fee levels are around 1.5%pa or less for everything including funds and advice – so bear this in mind when looking at a consultant.
- Deal with advisors who have technology that interacts with you and provide online support as part of their offering. If they are not planning for the future why are you planning your future with them?
- Deal with an independent advisor not someone who represents a company. An independent advisor has access to all products and companies and can objectively advise what is best for you.