Tax is becoming an increasing burden for South Africans, but with a retirement annuity, there are many ways to soften the blow. Here’s how.
A retirement annuity (RA) is nothing more than a one-person pension plan. It is a retirement fund. RAs are the main savings vehicle for self-employed people to accumulate funds for retirement in a tax-efficient way. They are also popular as a top-up plan for salaried employees (which includes directors of companies and members of CCs) who belong to pension or provident funds, to close the income gap at retirement.
Smaller employers often choose RAs for their staff over traditional pension schemes, thereby avoiding the administration costs and responsibilities involved in operating the latter schemes.
Most people know that contributions to an RA are tax deductible up to a certain maximum, but few people realise that an RA may actually provide them with an opportunity to save tax in 10 different ways:
1. Contributions are tax deductible up to a certain maximum (eg if you fall in the 45% maximum marginal tax rate, then SARS is sponsoring almost half of your contribution towards your retirement). The annual income tax threshold for over 65s is R117 300 and for over 75s it’s R131 150 – thereby reducing your chance of paying tax at all on the proceeds, despite the deduction.
2. Your employer (if applicable) can pay your contributions on your behalf and deduct it from tax without any limitation, but of course such payments by the employer rank as a taxable fringe benefit.
3. Disallowed contributions can be carried over to the next year of assessment and, if unused during the contribution period, can either be offset at retirement to increase the tax-free portion of the lump sum, or it can exempt pension income from tax to the extent of the unused disallowed contributions.
4. Since 1 March 2007, no tax on interest or rental income is imposed on retirement funds. This benefits anybody who pays tax and who belongs to a retirement fund. Therefore no tax at all will be paid on the build-up, as dividend income and capital appreciation is tax free and Capital Gains Tax is not applicable. This is like having a tax-exempt share portfolio. Dividend Withholding Tax (DWT is 20%) is not levied on retirement funds either.
5. Your retirement fund lump sums at death, disability or retirement in total are taxed at 0% up to R500 000. There is also no tax on disallowed contributions.
6. The balance of the lump sum is taxed on a sliding scale as follows:
R500 000 to R700 000 @ 18%
Between R700 001 and R1 050 000 @ 27%
Sums in excess of R1 050 000 @ 36%
Because you can stagger your retirement with an RA, you can mature your RA at any time after age 55. With an employer pension or provident fund, when you retire from your employer you can elect to either receive the retirement fund benefit or leave it to preserve in the fund. However, if left in the fund no further contributions can be made.
7. Since 1 January 2009, the entire proceeds of an RA (including the lump sum) are exempt from estate duty. This provides a planning opportunity for the estate owner to make a large single-premium contribution to an RA to reduce the value of his or her estate. (Just bear in mind that any unused disallowed contributions are deemed assets for estate duty purposes for deaths on or after 1 January 2016 in respect of contributions made on or after 1 March 2015.) You can also donate a lump sum to your spouse (donations tax exempt) thereby saving estate duty of 20%. The spouse can then use that money to fund an RA, which he or she can mature at 55.
8. If you resign from your employer and receive a withdrawal benefit from your pension or provident fund, you can preserve your retirement benefit by transferring it into either a preservation fund or an RA fund, on a tax-exempt basis.
9. On retirement, you have a choice between two types of compulsory life annuities, namely a conventional (with guarantee) annuity and an investment-linked living annuity, or a combination of the two. By choosing the investment-linked living annuity you can manage the income you receive (between 2.5% and 17.5% of the capital amount each year) and consequently also manage your income tax position. Another advantage is that any growth on the assets backing the annuity is not taxed (only the income you receive in your hands is taxed).
10. Many people experience a big increase in medical expenses once they retire. Thankfully, once you have reached age 65, your tax rebate on medical expenses increases. An RA can be used to build up a fund for post-retirement medical expenses in a tax-efficient way. On retirement, although the annuity is fully taxable, when the money is used to cover medical expenses, it is partially tax free again due to the medical tax rebate.
Surprisingly for many, the biggest advantage of an RA may not be tax related at all. An RA is a disciplined way of saving on a regular, contractual basis. The fact that the capital cannot be accessed before at least age 55 (except in the case of disability or emigration) often proves to be a blessing in disguise. It means you are more likely to reach retirement with some capital to produce a retirement income if you follow the RA route. This is in contrast to many other types of liquid investment which, experience shows, are raided for other purposes long before retirement.