The role of tax in finding the right retirement solution is vital.
Inflation and tax go hand in glove in diminishing hard-earned retirement savings, warns Geraldine Macpherson, legal marketing specialist at Liberty.
Ignorance of the impact of tax on retirement savings at the time of retrenchments, job changes or retirement may mean that retirement will not be comfortable or possible when planned.
Macpherson says many employers in South Africa have pension and provident funds. It will be compulsory for a new employer to be a member of the fund.
“The fact that you will be contributing to a fund is a really great start, but you cannot stop there. The amount contributed to your employer fund is not based on your specific needs. Make sure you do have some voluntary savings as well – money you can access should you have an emergency or if you are saving for a short-term goal.”
Macpherson says it is critical to preserve fund benefits while changing careers. “If not, you will have to use all your available resources, and make some hard decisions about what to cut back on in order to put as much as possible into saving for retirement.”
A financial advisor should be able to take their client’s personal investment portfolio into account, says Macpherson.
It is important to determine whether the client is using the interest and capital gains tax exemptions to the maximum. The advisor should also ensure the client benefits from any tax deductions he may qualify for.
“There are other products such as unit trusts and endowments, which are all beneficial to the client from a tax perspective, depending on what he already has in place and what his exact retirement goals are.”
Macpherson says that while there are certain incentives such as tax breaks associated with retirement funds, nothing should prevent a person from making use of voluntary investments to augment retirement savings.
This route includes unit trusts, endowment investment funds and share options.
According to Macpherson, investors have to bear in mind that contributions to these forms of savings are made from after-tax income and proceeds will be taxed.
There are some risks to consider when taking the voluntary savings route.
“There is no legislative or regulative safeguard against investing in very high risk portfolios. There is no big daddy mechanism to guide and protect you,” she says.
Regulation 28 to the Pension Funds Act imposes limits on the investments of retirement funds. These were intended to protect funds against making imprudent investments.
Macpherson says there is also no disincentive to prevent an investor from “dipping” into his voluntary saving prematurely, which may result in insufficient amounts available at retirement.
Retirement funds on the other hand have strict rules about premature access, and the tax penalties for dipping in early is harsh and permanent.
The South African Institute of Tax Professionals (SAIT) says the current South African retirement savings regime contains incentives, disincentives, defaults and specific legislative parameters.
The majority of these measures are intended to encourage and protect retirement savings. There are two tax tables that could apply to tax retirement lump sum benefits: a withdrawal tax table and a retirement; death and severance tax table.
Taxpayers are taxed cumulatively on all retirement lump sums received in respect of approved South African retirement savings.
Beatrie Gouws, member of the Sait personal income tax committee, says the low tax-free amount in the withdrawal tax table (R25 000) is to encourage retirement fund members to elect pre-retirement preservation through the disincentive of a low tax-free amount, and the loss of the tax-free amount at retirement.
Macpherson says members of pension and provident funds enjoy tax free growth when investing into retirement saving funds.
This should be viewed in light of tax payments of (at the top marginal rate) 41% on any income (including interest and rental income), 16.4% on capital gains tax and 15% on dividends withholding tax.
“There is an interest rebate and a capital gains tax annual exclusion, but that in real terms is of small consequence when you consider how much people should be saving in order to retire comfortably.”
Macpherson says a retirement savings fund (pension, provident and retirement annuity) and the tax-free savings vehicle are the only two options that are readily and easily available, and offers relief from tax while it is growing.
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