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Save thousands in tax by diversifying your retirement savings

It is crucial to find the balance between discretionary and retirement savings.

With increased tax rates on the cards for 2018, you may be looking to make the most of tax benefits for increasing your retirement savings. But numbers show how maximising your tax efficiency and achieving the best possible income in your golden years could instead mean finding a balance between your discretionary and retirement savings.

Danie Venter, a certified financial planner and advisory partner at Citadel Investment Services, notes that making sure that you are saving enough for a financially secure retirement is absolutely crucial, but warns that many investors fall prey to the common financial mistake of over-contributing towards their retirement funds.

The South African Revenue Service (Sars) allows tax deductions for contributions to a pension fund, provident fund or retirement annuity up to the value of 27.5% of the greater of your taxable income or remuneration. This deduction is also limited to an annual ceiling of R350 000.

“This represents a generous tax incentive to increase your retirement savings, but remember that your investment strategy should also take into consideration your tax consequences after retirement,” he says.

“It’s also worth noting that while contributions above these limits will be added to the tax-free portion of your withdrawal allowance at retirement, these contributions are not adjusted for inflation, losing their value in real terms.”

To demonstrate the benefit of having a savings mix, he offers the example of a 44-year old investor named Richard, who earns R62 500 each month or R750 000 per annum. Having lived frugally and saved faithfully from his first pay check, Richard now has R2 million in his retirement savings pot and is free of any other debt.

Venter then compares two scenarios based on Richard’s decision to focus solely on retirement savings, or opt to additionally build up a discretionary savings portfolio.

Scenario 1 – Saves 27.5% in retirement savings

Wishing to retire at the age of 65 years, Richard increases his retirement fund contributions to 27.5% of his salary, or R17 187 each month, amounting to a total of R206 250 every year. Without retirement savings, Richard’s total tax liability would equate to R212 490. Implementing the 27.5% contribution would then mean a tax saving of R81 000 every year, leaving him with a net annual income of R412 175.

Assuming that his contributions increase by 6% each year in line with inflation, and that his retirement portfolio delivers returns of 8.5% per annum net of fees, his retirement savings would ultimately be worth a princely R8.9 million in today’s value.

Richard next decides to withdraw the full one-third portion of his retirement savings allowed at retirement, amounting to just under R3 million. As the first R500 000 of the amount withdrawn from your savings is tax-free, Richard would pay a total of R822 349 in tax on this withdrawal or 27.6%

He then invests the remaining R2.15 million in a discretionary investment portfolio to ensure himself better access to his funds in the event of an emergency and R5.95 million remaining in his retirement savings, which he uses to purchase a living annuity. He selects a 7.5% drawdown level from both his discretionary and his retirement savings for income.

However, future withdrawals from his discretionary savings will be subject to Capital Gains Tax (CGT), which is capped at an effective tax rate of 18% for individuals and has an annual capital gains exclusion of R40 000 per annum. The income from his retirement savings on the other hand will be subject to Income Tax which could accumulate to marginal rate of 45%.

The table below reflects these principles in the 7.5% drawing made from both his retirement and discretionary portfolios.

By comparison, had Richard invested all his savings in a living annuity instead of withdrawing a one-third portion to invest in discretionary savings, he would need to withdraw nearly a third more from his living annuity each year to achieve a similar income, or at least R690 000 per annum. Which would then be subject to an effective tax rate of 26.2%, meaning that he would also be paying R70 000 more in tax each year than if he had invested a portion in discretionary savings.

Scenario 2 – Saves 15% in retirement savings and the balance in discretionary savings

In this scenario before deciding how best to save towards his retirement Richard consults a financial advisor, who advises him to consider implementing a discretionary savings portfolio in addition to his retirement savings.

Instead of investing the full 27.5% tax deductible portion of his salary into retirement savings, Richard chooses to contribute 15% of his salary or R9 375 every month to his retirement savings. His net annual income after tax would therefore change to R469 718, instead of R 412 175 where he maximises his retirement savings contribution (27.5%). Instead of spending this difference of R57 543 he decides to invest this amount in a discretionary savings portfolio.

Assuming that he again increases his contributions in line with inflation of 6% every year, and that he achieves the same 8.5% return net of fees, this means that at the age of 65 years Richard would have a total of R6.4 million in his retirement savings and R1.7 million in discretionary savings. The discretionary savings is then bolstered by withdrawing R1.37 million from his retirement savings, paying only R247 500 in tax. He then invests the R5 million remaining in his retirement savings in a living annuity.

To achieve a similar annual income of over R500 000 as in the first scenario, he would need to withdraw as little as R372 875 or 7.5% from his retirement savings each year, and supplement his annual income by withdrawing just under R223 948 (8%) from his discretionary savings. Resulting in a tax saving of R100 000 in comparison to exclusively contributing towards retirement savings.

Additional benefits of having a savings mix

Venter emphasises the need for flexibility in building your investment portfolio, pointing out a range of additional benefits to ensuring you have a savings mix.

For example, unlike retirement savings, discretionary investments are not restricted with respect to where you can invest. For example retirement vehicles restrict offshore exposure to 25%, whereas discretionary savings can invest fully offshore, allowing for protection against a volatile local currency.

“Also remember that once your retirement funds are converted into retirement income (or a pension), “emigrating” with the funds will not be possible as even should you decide to emigrate from South Africa, your income would first need to be paid into a South African Bank account.

“The wisest course of action is therefore to consult a professional financial advisor to help you develop a personalised long-term financial strategy tailored to your unique situation. This will help you to achieve the best outcomes whilst maintaining flexibility.”


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Good article, shows that tax planning matters for drawdown as well as contributions.
It is a bit of a moving target as tax rules change, but you should always look to drawdown in an efficient manner and know what type of tax your drawdowns incur (income, interest, dividend or CGT).

Also, I think that the CGT rate in the table above may actually be lower for discretionary than shown, not sure which assumptions were taken into account:
1. CGT tax rate is only 18% at the highest 45% marginal rate, the share owner seems to be below this in the example.
2. not sure if the base cost of the shares purchased was taken into account?

This analysis is not correct in my view. There are a number of points to note:
1) The main point is that investments into a pension fund, provident fund or retirement annuity (up to 27.5%) get a tax deduction. What is more important, however, is that any growth in these funds over the years is free of any tax. So any interest earned, dividends paid and capital gains made are not taxed in the fund, whereas you would be taxed outside the retirement fund. If you are taxed at the highest rate, this makes a significant difference over a long period of time. If you take money that would qualify for this investment and redirect it elsewhere, you will be taxed on all your growth over the period. The numbers above assume the same after tax growth of 8.5% irrespective of whether the growth happens in the retirement fund or in the discretionary savings. This is an incorrect assumption and does not take into account the after tax return. Assuming the exact same investments were made (e.g. Alsi tracker), the returns will be different. The discretionary option does given you a larger offshore allowance, but the above analysis is just assming the same after tax return in and outside of the fund.
2) Given the scale of a retirement fund into which employees contrinute, the fees should be lower than what a retail investor would achieve in a retail unit trust.
3) You should avoid estate duty for investments in a retirement fund, so in the event of death your beneficiaries would benefit from this saving. Also, no executor fees are payable on retirement funds which is a further saving.

Given this article was under the Citadel banner, I would realy like to see a response from them on this as the points raised above are quite important in my view. Thank you.

Agree with you. They are not comparing apples with apples, but it is still a good article. Time value of money, because of the immediate saving in tax, should be addressed more in detail in my point of view.

Maybe not a perfect article – so what; Tax on accrued interest and dividend income in the non-RA portfolio after capital withdrawals?

Nevertheless a value add article in that it puts quite a lot of meat on the bone and is therefore in some way verifiable by the reader. The detailed comments by some readers indicates that this is so. Was the R81 000 per year tax saving over 21 years taken into account in scenario 1?

Useful to me was that the LA capital value cannot go with you if you emigrate and appears that it can only go out month by month in the form of income. Have I read that right??? Maybe a way around this (depending on personal circumstances) is to max out LA withdrawals and then put back as much as one can into an RA. The RA contribution becomes a tax deduction against the LA income – then emigrate?

Well done Danie Venter for doing something different, provoking debate and adding value.

Take a bow.

I am a Citadel client, and the example as in Scenario 2 is exactly how my retirement planning is done.
I have challenged my financial advisor on maxing out my retirement fund contributions to 27.5% – they still insist after running the numbers that using a portion (15% in my case) to retirement funding and the balance to discretionary savings makes the most sense…and the most money.
In fact, were I not forced by my company to make retirement fund contributions, they wouldn’t advocate using a retirement fund at all!
Perhaps if you spoke to them they could run the numbers for you and you might be pleasantly surprised.

Are you saying you should or shouldn’t do 27.5%?

Don’t do the 27.5%. I have to because I am forced by my employer to contribute to the company retirement fund, but luckily only 15%.
Obviously the company retirement fund contributions are not enough for me to reach my retirement objectives, so I contribute extra into discretionary savings.
Citadel don’t advise using tax free savings accounts, but I disagree with them on that, so I make additional contributions to a TFSA as well, as part of my discretionary retirement savings plan.

More and more companies are looking into more ‘offshore’ focussed retirement plans.
Here’s a stat for you, the average percentage of people that invest into international retirement plans in the US is 40%, the average in Australia is 70%, guess what it is in South Africa: 7%.

In addition to all the points made, the following should also be taken cognisance of:
a) The time value of extending tax obligation with 25 or 30 years whilst contributing to a retirement plan;
b) The additional value of the tax free investment return gained over the accumulation term of a retirement plan (average of 30 years).
b) The benefit value of the 2 thirds eventual pension plan (annuity income after tax free lumpsum withdrawal) allowing for taxation down payment spread over balance of pensioner’s life time at a lower taxation rate than the pre-retirement taxation rate.
c) The value of exemption from capital gains- and estate duty taxation.
d) The so-called constraints of a retirement plan and pension income plan more often than not preserve retirement provision and protects most pensioners against family demands and their own financial discipline inability.
e) A pension income plan (income annuity) do not resort under the restrictions of investment prescribed regulations (off shore exposure).
f) Where so applicable, the effect of transferring other income assets to a spouseor child through means of donations taxation exemptions, allowing for transference and separation of discretionary income to a second and separate individual for taxation purposes (i.e. rental income) and thereby optimising the taxation rate of the retirement fund pensioner.
I however agree that articles of this nature are informative and allows the investor to contemplate different and appropriate scenarios.

I have always maintained that the swapping of dividend and CGT tax in a discretionary savings vehicle for future income tax at a potentially 45% marginal income tax bracket should be well understood before just taking the 27.5% tax break on offer.

Why you will take a tax break today only to pay income tax on that amount plus REAL growth plus INLFATION in the future is not always understood by all.

Still there are flaws in the argument presented here too.

One must know what the investor does with his tax savings. Not many save this aswell, therefore never really saved pre-tax money. In this case its not a good option. Hoever, those with self dicipline to calculate and save the tax benefit can reap the rewards of both the Discreationay and Tax Friendly options.

One should also not forget about a Tax Free Savings Account. All the “In Investment” Benefits of a RA, but no Income Tex when drawing the funds.

Daniemare, remember that Tax Free Savings Plans only arrived two years or so ago and the annual contribution limitation is currently R33 000 or R2750 per month. I agree that a TFSP should be one’s first port of call with discretionary savings up to the annual maximum as prescribed – especially if one opt for an ETF or share portfolio TFSP.

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