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Is it a good idea to use investment property as my pension fund?

New pension law about the one-third lump sum is a hindrance if I decide to leave SA.

I resigned from my previous job and the company I joined does not have a pension/provident fund. I am thinking of investing in property and regarding that as a pension. The other money I left it in the previous fund, but the downside is I can’t make any contributions to it.

I already applied for the second bond and it was approved by the bank. Apart from the rentals that will be collected, I will be paying an extra amount into the bond using the money that would have been going into the pension/provident fund. Is this a good idea?

The other thing is I am a foreign national and the new law about the one-third lump sum I don’t seem to like in case I decide to go back to my home country.

Firstly, congratulations on preserving the retirement benefit from your previous employer. You’ve avoided the retirement withdrawal tax now, while retaining the flexibility to take up to one full cash withdrawal before retirement age if, for example, you decide to return to your home country.

Should you decide to retire in SA, then by preserving the retirement benefit, you will have benefitted from continued tax-free growth, which will provide you with a better long term outcome in the form of annuity income.

If you are considering investing in a rental property in lieu of saving into a retirement annuity (RA), you will need to give careful thought to your lifestyle objectives in the long term. This would include the probability of returning to your home country either for a few years or permanently during your working life, and where you would ultimately see yourself retiring given your current circumstances.

Investment property vs RA – SA tax resident

In the absence of a provident or pension scheme with your new employer, you need to make provision for retirement savings in your private capacity. This would usually involve contributing to a RA.

From a pure investment perspective: although the investment property is a good idea in principle, it is sadly no substitute for a pension. The after-tax returns that you could achieve in terms of both net rental income and capital appreciation would not come close to total returns from a retirement fund.

This is the result of the tax deduction that is available on contributions to retirement funds (i.e. pension and provident funds and RAs). Currently, all SA taxpayers can claim a tax deduction for contributions to a retirement fund of up to 27.5% of taxable income, subject to a limit of R350 000.

For example – a taxpayer earning R40 000 a month, contributing 15% to a retirement fund (ie. R6 000), would save 36% in tax on the contribution.

In other words, an investment of R6 000 every month would actually only cost R3 840.

If we compound the full contributions over time, plus capital growth, the difference between an RA and any other investment asset, including property, that has been funded with after-tax money, is significant.

The higher the income you earn, the greater the tax benefit – particularly for those paying tax at the top marginal tax rate of 45%.

The advantage of this tax saving is that it effectively frees up more cash flow for other investments, or in your case, towards paying a bond instalment on a rental property in addition to an RA, for example.

The RA is a clear winner here – provided you make use of a flexible, non-commission based option.

Leaving SA: Withdrawal of retirement benefits: non-residents

Your concern about accessing the capital if you leave SA is valid.

In terms of the exchange control amendments effective from March 1, 2021, former SA tax residents will need to provide proof that they have been tax resident in another country for an uninterrupted period of three years before they may withdraw the capital from their retirement funds. Although you may be ordinarily resident in another country, you are nevertheless currently a SA tax resident by virtue of the fact that you are living and working here (the physical presence test).

The delay in accessing the capital if you have set up an RA could be problematic if you were relying on the capital to purchase a home overseas, for example.

Fortunately, however, this three-year rule would not apply to the preservation fund from your previous employer. Provided you have not already done a one-off withdrawal from the benefit, you would still be able to access 100% of the capital in your preservation fund (pension or provident) if you were to make a full withdrawal before age 55 (or the retirement age as specified in the fund rules).

The withdrawal from all your retirement funds would be subject to tax, with the first R25 000 tax-free, and the maximum of 36% applicable to the withdrawal amount exceeding R990 000.

Retirement – SA and non-residents

The change in retirement legislation from March 1, 2021 relates to the forced annuitisation of provident funds. In terms of this, provident funds will be subject to the same rule that already applies to RAs and pension funds in that the lump sum cash withdrawal at retirement is limited to one third.

At retirement age, you would retire from your RA and pension preservation fund. This would be more favourable from a retirement tax perspective (up to R500 000 of the cash lump sum would be tax-free), but you would need to factor in the requirement to purchase a pension/annuity with the remaining capital, which would be paid to you in SA (and would be subject to income tax). This would be the case irrespective of whether you retired here or anywhere else in the world – in the latter case, the restricted access to the capital can be mitigated to some degree through maximising living annuity drawdowns.

However, if you were a member of a provident fund with your previous employer, this legislation change would not apply to you. All benefits in provident or preservation provident funds at February 28, 2021, plus all future growth, will be considered as “vested benefits”, meaning that you could still take 100% as a cash lump sum at retirement if you chose to do so. This will also apply where a provident fund benefit has been transferred to a preservation fund. The retirement tax tables would be applied to the cash lump sum withdrawn.

However, these vested benefits would be reduced if you have made a withdrawal from the benefit, either when you resigned from your previous employer or from your preservation fund at a later stage. It’s therefore critical that you don’t consider this option if buying a property.

Leaving SA

If you are seriously contemplating leaving SA permanently in the not-too-distant future, then it may not be worth setting up an RA.

Apart from the three-year withdrawal restriction, the decision to set up an RA would also need to factor in what you are earning, the number of years for which you would be contributing, and your objectives, taking into account the proportion of the envisaged end capital relative to your preservation fund benefit.

Once you have taken all this into consideration, and particularly if your intention is not to stay in SA long term, then you may prefer the investment property option.

However, while we would generally always advocate paying off a bond as quickly as possible, there are exceptions to this.

For an investment property, the debt actually works in your favour – rental income would be taxable in your hands, less deductible expenses, which include the interest you are paying to service the debt on the property. In this instance, paying additional funds into the bond every month as a form of “pension saving” would reduce this deduction, and thus increase your taxable income.

Instead, in this scenario, the contributions that you would have made to your retirement fund during this period could possibly be invested offshore using your annual discretionary allowance, in anticipation of your returning to your home country.

Bear in mind that when you leave SA, you would need to factor in the time taken to sell the property if you need to take the capital offshore, as well as selling costs and capital gains tax on the sale.

Given the complex issues at hand and the need to look at your planning from a holistic perspective, you should consult an independent, certified financial planner for more detailed advice.

Do you have any questions you would like answered by registered financial planners?

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You should not be paying ANY INTEREST in retirement. If you do it offsets the money you are making.

There’s no easy answer here… But what other laws would you reasonably think the government would put in place.

Right now you’ve been blocked from taking retirement funds for 3 years. But what Draconian laws are coming next?!

End of comments.

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