A Moneyweb reader sent the following question:
I pay R16 000 in income tax per year. If I take out a new retirement annuity (RA) and start contributing to it, how would that reduce my annual tax burden going forward? I’m 72 years old now and have enough to get by on a monthly basis. I have no debt; all my kids are married and are out of the house. I only have to worry about my hubby and I. I’m able to contribute to an RA and would like to know how to structure this to get the maximum tax rebate possible?
Mduduzi Luthuli, co-founder and an executive director of Luthuli Capital, answers:
The above is a fantastic question. Your current income, along with your question, tells me that you take your retirement savings very seriously. I must commend you for this. South Africa needs more people with your attitude towards their retirement savings. A sad statistic is less than 6% of South Africans retire with a retirement savings sufficient to maintain their standard of living. Most South Africans face financial difficulty in their golden years – a really cruel and sad fate.
Before I touch on the tax advantages that contributing to an RA offers, I must first note your age. You stated you’re 72 years old now; to my knowledge most RAs have a maximum entry age of 69 years old. I stand to be corrected on this fact but I’m yet to come across an RA with a higher entry age. I hope this fact doesn’t deter you in pursuing means to actively grow and maintain your life-savings. Speak to a wealth manager to better understand what options are still available to you.
That being said, you still ask a very relevant and important question so allow me to briefly touch on the tax benefits of contributing towards an RA.
There are three tax benefits:
- Contributions are tax deductible – you may deduct up to 27,5% of your gross remuneration or taxable income (whichever is the higher) in respect of your total contributions to a pension, provident or retirement annuity fund, subject to an annual limit of R350,000. Also important to note is that you can invest in as many retirement annuities (RAs) as you wish, but the tax benefit is determined in aggregate, not in respect of each individual RA. In other words, the tax relief on contributions is limited to 27,5% of gross remuneration or taxable income (subject to the annual cap of R350,000), irrespective of the number of RA memberships. And the tax-free lump sum portion may be claimed only once. Remember the stated rebate of 27,5% is the maximum amount one can receive back and is not necessarily the amount one will receive.
- Investment returns are tax free – there is no income tax or capital gains tax on the investment return earned in a RA. Paying tax on the proceeds of your RA is deferred until retirement which means there’s a larger balance that’ll compound, tax free, for as long as you remain invested. This really can’t be understated because you get to utilise the most powerful force in the universe to grow your retirement savings. I’m not talking about love, I’m talking about compound interest. According to legend, Albert Einstein called compound interest “The most powerful force in the universe”. This may be up for debate but if you understand the true effects of compound interest, I’d doubt you’d disagree with Einstein.
- Benefits are taxed on a favourable basis – lump sum benefits are taxed on a sliding scale with a portion of the benefit tax free.
The above tax benefits are as close as you get to a free lunch; that, and diversification of your portfolio. Why is that, you may ask? Well, think about. In an RA you have an investment vehicle that gives you the following 3 attributes:
- A reduced tax burden because the government “pays” you a considerable amount of money to incentivise you to save for your own retirement. If I was to put one of my clients into an RA that returned an annual investment growth of 0%, and my client then decided to reinvest their maximum tax rebate of 27.5%, that’s is a net growth of 27.5% on your investment earned for simply having and contributing to an RA. Any other investment would have to achieve incredible returns just to compete with a retirement annuity.
- It forces you to learn the one of the hardest lessons in life, DISCIPLINE. With discipline very few things can’t be achieved. The biggest hurdle for people in investments that I have found, is the ability to stick to a long-term investment plan. How do you get someone to save towards their retirement for 20/ 30/ 40 years when just 1 year seems like asking for a miracle. Don’t allow them access to their cash prior to age 55 years. You cannot access your retirement annuity before you are 55 years old. If this sounds like a disadvantage consider that the main reason those who save for retirement fail to sustain their living standard when they kick back is because they cashed in their pension fund when they changed jobs.
- Thirdly, it’s safe from your creditors. Your retirement savings are safe irrespective of any personal financial loss you may suffer. This ensures that your savings will be available when it is most needed and for what it is intended – the provision of your retirement income.
The above are just some of the reasons savings towards your retirement income is best done through an RA. I hope I’ve made my point and if I haven’t convinced you yet, book an appointment with a Wealth Manager, such as myself, and let’s further discuss the great benefits of an RA.