Retirement funds and tax
When trying to find an appropriate investment, one needs to look at various factors. You need to ask yourself a number of questions: Is your primary need to grow your funds and access them over the next few years, in which case you might want to consider unit trusts or a money market type account? Maybe you would like to invest for a long period of time but are concerned that an emergency might mean that you unexpectedly need to access some of your funds over the next few years. This might make tax-free investments or at least a combination of different types of investments attractive. There are many factors that you need to consider before choosing an appropriate vehicle. Factors such as term of investment, acceptable risk, age until retirement, investment product features, and costs make choosing an appropriate investment quite difficult. However, if tax is your primary consideration then it is hard to find an investment more attractive than a retirement fund.
Trying to understand the full tax regime around retirement funds can often prove quite difficult. The easiest way to understand the effects of tax on retirement funds is to break the investment up into three tax events namely, going into the fund, within the fund and coming out of the fund.
Going into the fund
This is the contribution stage of a retirement fund. One of the greatest advantages of contributing towards a pension fund or retirement annuity (provident fund as well from 1 March 2016) is that retirement fund members are entitled to deduct contributions made to their retirement funds up to a certain maximum from their taxable income (see Diagram 1). This in effect means that SARS ‘subsidises’ up to 41% of your contributions towards a retirement fund. Assuming that your marginal rate of tax is 41% it would mean that up to R410 of every R1000 earned will go to SARS. That leaves you with R590 to invest. Assuming that the entire contribution is tax deductible, contributing towards a retirement annuity would mean that you would be entitled to claim back the R410 due to SARS which in turn means you would be entitled to a return of R410. That’s almost a 70% return that you are entitled to before your actual contribution to the retirement annuity starts earning a return. This is the primary reason why if you look at investments purely from a tax perspective, you will be hard pressed to find any other type of investment that compares to a retirement annuity.
Within the fund
Another tax advantage of a retirement fund, which becomes relevant as your investment grows, is that there is no tax on the interest or dividends earned by the investment as well as no capital gains tax on gains within the portfolio. This means that you can benefit from years of tax-free investment growth within a retirement fund, which will help towards increasing your investment returns.
Coming out of the fund
Certain tax benefits apply when you take out money from your retirement fund. You are entitled to R500 000 tax-free on any lump sum received at retirement as well as R25 000 tax-free when you withdraw from a retirement fund (see table). Any annuity received will be taxed at your marginal rate of tax but generally one finds that their tax rate often drops at retirement with larger tax rebates. The other massive advantage of a retirement fund is that there is no estate duty payable on any approved retirement fund, saving a retirement fund member up to 20% of their investment value.
Tax is only one of the many factors to consider when seeking an appropriate investment. Many people however ignore the significant tax advantages purely because they seem difficult to understand. With the assistance of the diagram, we hope that you will find yourself in a better position to understand the tax advantages of a retirement fund as well as the consequences of some of your actions while you are a member of a retirement fund.