Tax should be top of mind when structuring a retirement savings plan
South African savers have a tough time. On the one hand government and National Treasury are begging them to tuck away additional funds toward their retirement, while on the other the South African Revenue Services (SARS) is doing its level best to squeez
If the experts are concerned about the current state of national retirement provisioning one can only imagine the situation once employees begin contributing to the proposed National Health Insurance (NHI) solution. National Treasury has not yet revealed details of the NHI funding model, but you can be sure a significant payroll tax will be levied. There is also growing concern that the domestic economy will remain in its current “muddle through” state for much longer than expected. Lower returns across asset classes could put additional pressure on retirement savers, especially those in the wealth accumulation life stage.
A holistic retirement planning process
Against this gloomy backdrop it is essential that you approach the financial planning process holistically. Aside from considering the goals and objectives set out in the Financial Needs Analysis you must consider the tax and fee implications of the savings products you recommend to your clients. The retirement annuity (RA) is often held up as a tax efficient retirement funding vehicle, so we will expand on the holistic planning concept by comparing it to another popular long-term saving vehicle, a portfolio of unit trusts.
At first glance the major difference between an RA and a portfolio of unit trusts is access to the accumulated capital. An investor can access the funds in his unit trust portfolio at any time, whereas the capital balance in an RA is only accessible upon reaching a pre-determined age (minimum 55-years). Being able to access your unit life savings is not necessarily a positive as many savers dip into these funds during times of financial stress or to fund unnecessary lifestyle expenditures. There are significant tax differences between these two structures too. The most notable among these is that the RA can be funded from pre-tax money (assuming the investor avails of current tax concessions) whereas discretionary savings in a unit trust portfolio are funded post-tax, from a savers net salary.
Your client can claim a tax deduction for retirement annuity fund contributions equal to the greater of 15% on non-retirement funding taxable income, R3500 less current contributions to a pension fund, or R1750.
Budget 2012 gives retirement annuities another boost
Recent changes to South Africa’s taxation regime have created an investment utopia for government “approved” retirement funding vehicles such as RAs and pension and provident funds. The myriad investments within an RA are not subject to taxation! What this means is that the RA member does not pay Capital Gains Tax (CGT), Dividend Withholding Tax (DWT) or any Income Tax on the capital gains, dividends or interest earned within the RA structure. Incomes and gains in the unit trust portfolio are taxed as follows: CGT 13.3%, DWT 15% and interest at the taxpayer’s nominal tax rate.
John Kinsley, chief operating officer & MD of unit trusts at Prudential Fund Managers published an interesting comparison between an RA and unit trust portfolio following the tax changes announced in the 2012 Budget. In his 26 July 2012 article (published on moneyweb.co.za) he concludes that the taxation changes mentioned above could result in a 0.5% per annum excess return for the RA saver over the unit trust investor.
It does not sound like much, but in his comparison an investor saving R2 500 per month in an RA, from age 35 to 60, would be better off than his balanced fund peer to the tune of R1.5 million. Kinsley assumed both funds achieved inflation plus 5% (after investment management fees of 1% per annum) and pegged inflation at 6%. (One might argue that the unit trust investor would expect higher returns than his RA counterpart – but the purpose of the exercise was to isolate the impact of taxation on long-term returns).
The benefit to the RA investor is even more noticeable after 20 years in retirement. At retirement the RA investor can move 100% of the RA into a living annuity (remember he is R1.5 million ahead of his unit trust competitor at this stage) and draw a monthly salary, which is subject to income tax. The unit trust investor can simply sell units to provide this salary with no additional tax concerns, bar CGT. At age 80 Kinsley reckons the living annuity end capital value will be R9.2 million versus R3.2 million in the unit trust portfolio.
Sensible retirement planning
“Investors have different circumstances and views, and some may regard having more control over their money, as in the case of investing in a balanced unit trust, as essential,” concludes Kinsley. “The final decision will always remain a personal one, but the numbers certainly do tell a story that is worth considering”.
Your clients’ retirement plan should be about more than saving enough of their salary each month, beginning saving early enough and always preserving. Successful retirement planning requires collaboration between product provider, adviser and client… And a holistic solution must take into account growth and inflation expectations, taxation upon entering and exiting a product, and fees.
Editor’s thoughts: There are too many variables to successfully compare one retirement savings strategy against another… In a theoretical world, where certain variables can be neutralised, it is possible to draw conclusions. Would you agree that the impact of Dividend Withholding Tax, Capital Gains Tax and income tax on interest makes retirement annuities a better option than unit trusts? Please add your comment below, or send it to [email protected]
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