Beware of tax traps when choosing a retirement solution

Taxing matters.

South Africans are spoilt for choice when it comes to retirement savings products, however many forget to consider the tax implication of their choice.

Although government has made huge strides in harmonising the tax treatment of the different saving vehicles, there are still some tax traps for the unwary and the careless.

The 2013 FinScope survey indicated that the number of adults who do any saving at all is around 42%, with only half of those saving through formal channels.

Faeeza Khan, legal marketing specialist at Liberty Group, says the five main options in those formal channels are compulsory pension and provident fund contributions, retirement annuities, pension and provident preservation funds, tax-free savings accounts, and endowment and unit trust investment options.

Pension and provident funds

Pension and provident fund contributions are normally part of an employer and employee relationship, while retirement annuities are available to self-employed people, or those who want to supplement their existing pension or provident fund contributions.

Khan says that until last year, the tax treatment depended on the type of fund you were contributing to. Tax deductions on contributions to a pension fund were limited to 7.5% of a person’s pensionable income.

Deductions on contributions to a retirement annuity were limited to 15% of the non-retirement funding income. Contributions to provident funds received no tax deductions.

Khan says: “Effective from March 1 2016 tax deductions on contributions to retirement funds were harmonised. If one contributes to a retirement fund – whether it is a pension or provident fund or retirement annuity – one will get a tax deduction based on the greater of remuneration or taxable income.”

Khan explains that the allowable tax deduction is now capped at 27.5% of whichever is the greater (remuneration or taxable income). Contributions beyond R350 000 per annum will constitute disallowed contributions.

“The majority of individual taxpayers’ only source of income is remuneration (a salary with no additional income such as rental or dividend income). Taxable income is the amount left after all the exemptions and allowable deductions are subtracted from gross income.

“If remuneration or taxable income is not greater than around R1.2 million the 27.5% or R350 000 per annum cap will not be exceeded. Most South Africans will be well within this cap, so it is quite a generous offer to encourage people to save,” she says.

A further offering is that although contributions exceeding the cap will not receive a tax deduction, the disallowed deduction will roll-over on an annual basis until retirement.

This means that the pot of disallowed contributions can be added to the tax-free lump sum of R500 000 at retirement.

Taxing matters – Any growth in pension funds, provident funds and retirement annuity funds are tax free.

Contributors to pension funds and retirement annuities are allowed to take one third of the retirement fund at retirement, however it is mandatory to reinvest the remaining two-thirds in a compulsory annuity.

Provident funds allow the contributor to withdraw the full value of the fund at retirement.

The retirement lump sum tax table allows for the first R500 000 as a retirement amount to be tax free, thereafter withdrawals are taxed according to a sliding scale (see table).

For example, if a taxpayer contributed beyond the 27.5% or R350 000 per annum and has accumulated roll-over disallowed contributions of R500 000 this gives him a tax-free lump sum of R1 million.

Khan says that should the taxpayer choose to take only a R500 000 tax-free lump sum any disallowed contributions accumulated to the annuity income so that the taxpayer receives a tax-free income until all disallowed contributions have been applied to the income.

Beatrie Gouws, member of the South African Institute of Tax Professionals’ (Sait) personal income tax committee, says the tax incentives within the South African retirement savings regime strongly encourages long-term saving for retirement as opposed to immediate consumption.

“It follows that tax must be a strong consideration when determining the best retirement solution for oneself,” she says.

Preservation funds

Pension or provident preservation funds are used to house accumulated savings when an employee moves from one employer to the next. The money can be transferred tax-free from the previous employer’s retirement fund to a preservation fund.

Liberty offers products which ensure the continued growth and preservation of retirement fund savings. The Agile Pension and Provident Fund Preservers allow members of existing pension or provident funds to transfer their existing, accumulated benefits on termination of their job (resignation, winding-up or retrenchment) into this investment tax free.

Endowment and unit trust funds

Endowment investment options are short-term investments with a fixed term, generally five years. Unit trust investments, however, are more flexible with no fixed term and investors have access to their funds at any time.

Taxing matters

Contributions to endowment investment funds are made with after-tax money. Any interest, dividend income or capital gain earned in the fund is taxed in the fund. However, at the end of the five-year term, the proceeds are tax free.

Khan explains that the rates at which the individual are taxed in terms of the five fund tax approach are quite “lenient”.

Income is taxed at 30% (even if the individual’s marginal tax rate is 41%), capital gain is taxed at 12% (even if the individual’s effective capital gains rate is 16.4%).

Accessing funds before the end of the term could result in a penalty on a sliding scale.

Unit trust investors may access their funds at any time but the tax rates are not as lenient as with endowment investment funds. Normal rates for income and capital gains apply.

Tax-free savings account

This savings vehicle was been introduced in 2015 and is also available as a supplement to existing savings. Contributions are made with after-tax money, there is no tax in the fund and proceeds are tax free.

Taxing matters – Investors should however be wary of “over-contributions” as the penalties for doing so are “quite severe”, Khan warns.

One is allowed to contribute up to R30 000 per annum and up to R500 000 per lifetime. Contributions beyond these thresholds will result in a penalty tax of 40%, payable in the year of assessment in which the over contribution was made.

Table: Retirement fund lump sum benefits or severance benefits:

Taxable income ( R ) Rate of tax ( R )
0 – 500 000  0% of taxable income
500 001 – 700 000 18% of taxable income above 500 000
700 001 – 1 050 000  36 000 + 27% of the amount above 700 000
1 050 001 and above  130 5000 + 36% of the amount above 1 050 000

Source: Sars

This article is brought to you by Liberty Agile.


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Can someone please explain below paragraph? Does this mean you can claim the disallowed contributions from your monthly annuity income after retirement up to the 27,5% limit?

Khan says that should the taxpayer choose to take only a R500 000 tax-free lump sum any disallowed contributions accumulated to the annuity income so that the taxpayer receives a tax-free income until all disallowed contributions have been applied to the income.

Yes, it will be treated like you are contributing to a retirement fund still. So you’d pay less tax on your pension income.

You should also be aware of Liberty when you choose a retirement solution.

Why – my experience with them is that they embedded their costs in the overall product – which is unhelpful

Indeed, I know many people who complain about Liberties high fees, and sub par performance…

Im sure its R 33000.00 per annum from this year

Check their previous article, they are not very Agile with updating these “articles” with new facts.

People are not savings because its too complicated. We really just need three different savings accounts:

1. Pension fund for tax deferred saving.
2. Tax free savings account.
3. Taxable savings account.

Yes, every reader should be well aware that this is a Liberty sponsored article, so written with significant bias. There’s no mention of Regulation 28 restrictions on retirement savings, which is an important consideration. That limits one’s investment options, notably foreign asset component. Reg 28 isn’t applicable to other products mentioned, so tax considerations should be weighed up against Reg 28 restrictions too when making choices.

I don’t agree on an endowments being “short-term investments”. Certainly shorter than most retirement products, which depend on the investor’s age and retirement date, but 5 years isn’t “short-term”. There’s limited accessibility within endowments, but certainly full flexibility when it comes to underlying investment options.

The FSB needs to seriouly look at the behaviors of old mutual and liberty- they push endowments down everyone troat(through FA) whose not even at the correct tax bracket for endowerments

The FSB only protect the life assurers like Liberty and Old Mutual. We all know how much miss-selling has gone on for far too long, yet it still goes on today. All we can do is get to as many victims as we can and help get them to better providers and better solutions. Expecting the regulators to regulate is just asking too much.

End of comments.



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