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Can I get tax benefits from contributing to my kids’ RAs?

Considerations when contributing toward retirement annuities and other long-term investments for your children.

I would like to invest in a retirement annuity (RA) for my minor children. Would I be able to deduct the contributions I make on their behalf from my taxable income?

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Anyone who contributes to a pension fund or retirement annuity (RA) is entitled to claim a deduction for tax purposes based on their contribution, subject to the limitations applicable at the time of the contribution. However, the fund or annuity must be in their name. So while you can contribute to an RA in the name of your child, you would be unable to claim a tax deduction on the contribution.

How can you still claim the tax deduction?

A possible alternative is to open an RA in your personal capacity with the intention that, upon your death, that particular RA passes to your named beneficiaries, which in this case would be your children. In this instance the contributions would be tax deductible subject to the limitations.

In this example should you have a claim made against you in the event of a divorce, the RA may be open to a judgment by the courts, despite the fact that you initially intended it to be for the sole benefit of your children.

Similarly, in the event of your death, should the pension fund trustees find that you have a financial dependant, they have the ability to provide for that dependant before considering the named beneficiaries of the RA.

Although these may seem unlikely scenarios at the time of opening an RA in your name (should that be your chosen route) you must be aware of the possible eventualities that may affect your overall intention.

According to current legislation, on your death your named beneficiaries will have the choice of taking the value of the RA as a discretionary lump sum (to invest or spend as they see fit) or to have the RA transferred into their name where they can eventually turn it into an annuity income. You are unable to specify how your named beneficiary is to receive the benefit.

My first priority is to help provide for my children’s retirement

As mentioned, you can contribute to a RA in their name which is secure from creditors and inaccessible until age 55. The RA can invest in different asset classes to differing degrees. This may include high growth or conservative growth. This is an option to consider as it has the benefits of growing tax free and is protected from creditors.

The legislation that governs the restrictions in terms of what the underlying investments may be within a pension fund is commonly referred to as Regulation 28. This controversial regulation restricts the amount of growth assets that can be included in the RA. If the investment is to be invested for a period of 40 years, it may be worth considering the use of a tax-free savings account. The benefit of a tax-free savings account is that it grows tax free, as an RA does, but is not required to invest in compliance with Regulation 28.

In the case of a fund that is compliant with Regulation 28, they may only have a maximum offshore exposure of 30%. Over a 40-year period it may be more appropriate to have an unconstrained mandate that can diversify into more companies listed around the world, which may have higher growth potential than South African asset classes.

The disadvantage of having a tax-free savings account as a retirement savings vehicle is that the money can be withdrawn at any point in time by the account holder. This gives the investor the temptation to use the money should they wish to spend it in circumstances that can be considered non-essential, such as home renovations.

What would a small contribution look like over a very long period of time?

The following scenario is an example of how powerful compounding can be over a very long period of time. Consider a relatively small starting contribution of R500 per month, escalated annually by inflation over 13 years to reach a total nominal contribution of R78 000. Given a realistic return target of inflation plus 5%, the total equivalent contribution of R78 000 grows to R593 154 (all quoted in today’s value of money).

Assumptions

Starting age             

Eight years old

Investment time horizon (years)

57 years (to age 65)

Nominal annual return after unit trust fees

11%

Inflation rate

6%

Net annual return

A number of well-known South African managers have consistently outperformed this benchmark with their balanced funds over a long-term time frame

Inflation + 5% (considered to be a realistically achievable target over such a long period of time)

Starting monthly contribution

R500

Contribution period

13 years (to age 21)

Annual escalation of the starting contribution

6% (inflation)

* No financial advisor or platform fees have been included.

Outcome

Nominal return (the rate of return on an investment without adjusting for inflation)

R16 428 659

Real return (a real rate of return is the return on an investment that has been adjusted by inflation)

R593 154

Source: Allan Gray Financial Planning Tool

At the age of 65 the investor would have just less than R600 000 in terms of today’s value of money, which they can add to their retirement saving in order to produce an income in retirement.

  

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ADVISOR PROFILE

Jesse Morgans

Asset Protection International

COMMENTS   8

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Why not invest in the child’s name in a tax free account?
Yes the contribution is not tax deductible but the tax free account far outweigh the tax deduction allowance from your income.

When you eventually withdraw an income from the RA (which is switched to a pension) you pay tax on the income (as if you earn a salary) but any withdrawel from a tax free account is tax free.
Yes there are risks in private investing but so is there in the RA route. But that is another discussion.

Or am I missing something?

Whilst I can see the obvious reasons for the question is the Tax Free benefit and the advisor’s response to that and I understand the need to start saving early for retirement.

What I do not understand is selling such an encumbered (to the Government) product over such a long timeline at all. Would it not be better to pay the Tax now and put this into savings for your children.

My logic is that to have this money encumbered to a Government that we cannot tell what is going to do in the next week never mind the next fifty to sixty years. You never know, they need cash and come and give these savings a haircut.

Why would any parent want to tie kids money up for 40+ years ? Rather set up a tax free investment for them. Just remember that if the investment is in their name when they turn 18, they gain full control over it which may not be optimal.

The problem is that if you put the kids RA’s in your name along with other retirement monies in your name your children will not be able to apply the tax dispensation on retirement and severance lump sum payments available to them as tax-payers when they retire as the money will be in your name, not theirs. This assumes you and the children are both alive at the point at which they would like to access the money. In short, there might be good intentions in doing this but many constraints with current legislation and who knows what will happen in the next 30 years. The kids might also decide to immigrate.

Lets lock some cash away for my kids for 50+ year… Not a chance mate… You need to be able to access that cash and move it quickly… Dont trust the RSA government one iota in the long run… They will inflate the value away, insist you invest it sub-optimally, just so you can avoid funding their thieving in the short term? Pull the other leg…

You can donate R100k per year free of donation tax. So open a broker account and put R100k per year into equities. The brokerage fees will be a fraction of advisor and asset manager fees. Yes a CGT problem but at that age CGT likely non-issue and big chunk of house paid for. No, there is no direct tax benefit for you, but all that contribution is also outside your estate tax…

I have a contrary view. Invest in education as high and/or as specialised (in demand) as possible; maybe tax deductible through a bursary type scheme, send them overseas on business, if you have one. Set up a business with assets that can be relocated outside of SA for them, the investment will be tax deductible. Otherwise forget the tax angle; just put money away for them in Euro’s or US$. They will thank you sooner than in 40 odd years.

All the clever Trevor’s amazes me how people forget about behavior and how easy people need to access funds. Will your children marry well, make good life choices, create business, carry on the businesses. Because businesses don’t go under, because marriage is forever, because it could never go up anybody’s nose. I’ve seen it all trusts the lot, if people want to access money they will. Giving your child a three decade head start on retirement savings is golden. I wouldn’t mind getting a nice little surprise at 55.

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