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Tap into tax benefits this February

13 February 2024 Allan Gray

If you’re saving for your retirement, both retirement annuities (RAs) and tax-free investments (TFIs) are good investment choices.

But which one offers the best tax benefits? The answer, according to Carla Rossouw, head of tax at Allan Gray, depends on your investment goals and unique circumstances. “While there are tax benefits associated with both RAs and TFIs, the benefits are structured differently, and the product rules and restrictions are quite distinct.”

Tax benefits of retirement annuities
While pension and provident funds are made available through an employer, an RA is held in an investor’s personal capacity. “RAs are a good way to save for retirement for those who are self-employed or those looking to supplement their employer’s pension fund,” she says.

The principal tax benefit of RAs is that they offer tax savings now. In other words, you pay less tax now because you make contributions with earnings which haven’t been taxed. “However, you will pay tax when you retire and draw an income,” states Rossouw, “although this will probably be at a lower rate than your current tax rate.”

Another advantage is that you can claim a tax deduction for contributions to all retirement funds, up to 27.5% of your taxable income, capped at R350?000 per tax year. “While you naturally come out with less take-home pay per month if you increase your RA contributions to enjoy the maximum tax benefit, a smaller portion of your salary goes to the tax man,” explains Rossouw.

Taxpayers also have the option to make once-off additional contributions to an RA within a particular tax year. “You can consider this approach if you prefer to maintain a certain level of disposable income throughout the year by keeping your monthly RA contributions at a minimum,” she says.

The good news is, if you contribute more than the annual limit, your extra, after-tax (non-deductible) contributions (excess contributions) can benefit you throughout your lifetime: They can be carried over and deducted in the next year, and they continue to be carried over until they are fully utilised – so the benefit is never lost. Excess contributions can be used to increase the value of any tax-free lump sum you take before or at retirement; reduce the taxable portion of your living annuity income in retirement and/or reduce the taxable portion of any lump sum your beneficiaries choose to take as cash on your death.

Restrictions with RAs
However, there are trade-offs. Firstly, there are investment limits with RAs. “According to Regulation 28 of the Pension Funds Act, you can have a maximum of 75% exposure to equities and a 45% allocation offshore,” states Rossouw.

Secondly, there are liquidity limits. “Except under certain circumstances, your RA can’t be withdrawn before retirement and at retirement, your access to cash is limited,” she explains. This restriction will ease somewhat with the implementation of the two-pot system in September 2024. “From this date, all future contributions to pension funds, provident funds and RAs will be split into two components: one-third will go to a savings component and the remaining two-thirds to a retirement component.”

Before they retire, members will be able to withdraw 100% of the savings component, subject to a minimum withdrawal of R2 000. “The retirement component must be used to purchase an income-bearing product in retirement, such as a living or guaranteed life annuity, which will provide you with an income after you retire,” she says.

Lastly, there are estate-planning limitations. “RAs do not form part of your estate,” Rossouw states. “Although you can nominate beneficiaries, the trustees of the fund are ultimately responsible for allocating your benefit when you pass away.”

What about tax-free investments?
A TFI is a great way to boost your savings and invest for the long term. “Although you invest with after-tax money, you pay no tax on the interest, capital gains or dividends you earn,” Rossouw says. “Unlike RAs, there are no asset class restrictions, and you can access your investment at any point in time.”

However, there are restrictions in terms of how much you can contribute, which may not allow you to retire comfortably. “SARS allows taxpayers to save a maximum of R36,000 per tax year and R500,000 in your lifetime tax-free and there are tax implications for overcontributing,” she explains. “You can incur a tax penalty of 40% on any amount over the contribution limits.”

There are also estate-planning benefits. “It your TFI is structured as a life policy, the investment can be paid to your beneficiaries immediately and there are no executor fees.”

Maximise your tax benefits
Ultimately, it’s up to investors to decide which investment vehicle best suits their needs. “It’s not necessarily an either/or decision,” comments Rossouw. “Combining an RA with a TFI might provide the best outcome from a liquidity and tax-saving perspective, since it offers the best of both worlds.”

She urges investors to speak to their financial adviser well before 29 February if planning to make use of the tax concessions. “Annual tax benefits are forfeited if you don’t make use of them before the tax year-end. Make sure you send your instructions, supporting documents and payment well before the deadline.”

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