Smart to pay tax now and later on retirement funding – Imara

Consumers are in danger of outsmarting themselves on tax strategies around their retirement funding.

The warning comes from Imara Asset Management, South Africa, a company often consulted by high net worth individuals seeking affordable solutions.

A common error is the belief that tax planning involves a choice between deferred tax impacts and paying tax upfront so investment proceeds are tax-free later on.

“It’s not an either-or proposition,” says Mark Cunningham, a director of Imara Asset Management. “It’s often a smart move to pay tax now and later. That way you can optimise all the options – payment into your company retirement fund, additional provision through retirement annuities (RAs) and discretionary personal saving.

“Typically, the product mix across a retirement and personal saving plan will include tax-deferred products and products that are taxed upfront. Make use of both, but first obtain the advice of a qualified financial adviser who can explain all the likely impacts on investment build-up.”

No matter how the retirement and investment strategy unfolds, the authorities will not miss out on their tax-take.

Two popular upfront tax options are endowment policies and dividend earnings from share portfolios. Dividends are currently tax-free as the 10% tax on dividend income to be paid on behalf of the shareholder by the company issuing the dividends is yet to be enacted. Even after enactment, returns will still be “free of tax” in the investor’s hands.

Tax on the proceeds from an endowment policy are paid on the four-funds basis by the financial service company providing the product, creating a ‘tax-free’ payout to the individual investor on maturity.

In contrast, tax relief is obtainable on payments into a company retirement fund (a 7,5% tax benefit on retirement funding income) and on contributions to RAs (15% relief on non-retirement funding income), but the ultimate proceeds will be taxed in the hands of the consumer on cash commutation and income drawings, though the tax calculation was simplified in the 2008 Budget.

“Diversification across various product types irrespective of tax treatment is almost always a good idea,” says Cunningham.

“For those paying the top marginal rate of tax and for whom it is a priority to limit further tax exposure, it is possible to structure a share portfolio that will deliver solid dividend flows which can provide tax-free income to the shareholder.

“Those who receive large incentive payments on top of their basic pay might usefully look at RAs. The tax treatment of the two options is totally different, but the test is the optimum outcome in each set of circumstances.”

In recent years, innovation at financial service groups such as Imara has created extremely flexible products that can be adjusted to fit specific needs and risk profiles.

“Product structures and retirement planning approaches are increasingly flexible,” adds Cunningham. “These opportunities can be maximised by consumers who are equally flexible and engage in regular planning reviews.

“Rigid, preconceived ideas about the relative merits of upfront or deferred taxed vehicles can hinder effective retirement planning. But there’s one thing you should never defer – that’s access to good advice from a qualified professional.”