Boost your client’s tax-free retirement savings

Combining your client’s retirement fund contributions in, for example, a retirement annuity (RA) with a tax-free investment (TFI) could extend the period over which your client will receive an income at retirement by as much as 12 years.

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Given the increasing longevity, ensuring that your clients receive an income up to the age of 89, rather than just 77, can make the difference between a comfortable old age and one fraught with worry and suffering.

Since interest, dividends and capital gains are not taxed while invested in an RA, the product remains a great mechanism for your clients to save for retirement. Furthermore, since 2016, investors have also been allowed to claim a tax refund of up to 27.5% of total annual income (capped at R350 000) if this is invested in a retirement fund.

Examples of retirement funds include pension and provident funds and retirement annuities. This significant tax deduction is an incentive for South Africans to top up their annual RA contributions.

With many South Africans ending up spending this tax refund on some immediate need, they are missing a big opportunity in the tax-free investment (TFI) introduced in 2015.

Investing R36 000 per annum and up to R500 000 over a lifetime* in a TFI vehicle ensures tax-free interest on growth and dividends with no capital gains tax as well. Importantly too, since TFI vehicles are not, like retirement funds, subject to Regulation 28, TFIs can invest in higher-risk local and international equities and property funds with higher potential returns and no legislative limits.

With many South Africans ending up spending this tax refund on some immediate need, they are missing a big opportunity in the tax-free investment (TFI) introduced in 2015.

The advantages of leveraging RA tax benefits in combination with the other tax benefits offered by TFI vehicles are illustrated in the following three scenarios.

Saving for retirement by combining a TFI with an RA versus using an RA alone

Let’s assume a 28-year-old investor is saving R5 000 a month for retirement, aiming to retire at 60. Let’s also assume the contributions increase 5% each year with inflation. At retirement the investor’s aim is to receive an after-tax income equivalent to R20 000 a month in today’s value of money.

Scenario 1: The investor contributes R5 000 a month in an RA only (with contributions adjusted annually for inflation) until retirement at the age of 60.

Scenario 2: The investor contributes R5 000 a month but split across an RA and a TFI, with R3 000 going into a TFI, until it reaches the lifetime limit of R500 000, wherein those contributions will be redirected into an RA. Furthermore, the TFI contributions will be invested in an offshore unit trust to gain exposure in the high-risk high return offshore market.

The balance of R2 000 is then invested in an RA (with contributions adjusted annually for inflation) until retirement at the age of 60.

The scenarios also assume that:

  • The investor receives a return of inflation plus 4-5% (9.5% per year) after all costs on the RA and inflation plus 5-7% (11% per year).
  • The investor does not re-invest his SARS tax deduction since, in practice, most people spend this money although they should re-invest it to grow their retirement nest egg even more.
  • The investor converts his savings into a living annuity at retirement, with the initial 2.5% withdrawn and the balance funded from the TFI.
  • Where there is no TFI the 2.5% is automatically increased until the 17.5% legislative limit is reached on the proposed living annuity investment.
The outcome of Scenario 1 (investing through an RA only)

In this scenario the investor can sustain the desired R20 000 a month income after-tax in today’s money until the age of 77 years when reaching the 17.5% legislative income limit on the retirement funds.

The outcome of Scenario 2 (combining an RA with a TFI)

In this scenario, the investor can sustain the desired income of R20 000 a month after-tax in today’s money until the age of 89 years old when the TFI is depleted, and the 17.5% legislative threshold on retirement funds has been reached.

Tiaan Herselman, Head of Advice at Old Mutual Wealth

Combining an RA with a TFI vehicle will allow your clients to increase the lifetime of their desired income by an additional 12 years compared to when using an RA only.

These results don’t only illustrate the potential benefits of the TFI when used in tandem with an RA, but also show how your clients can earn a higher return over the long term as a result of unlimited exposure to the riskier local and offshore asset classes such as equities and property.

The tax refund of up to 27.5% of total annual income capped at R350 000 invested in an RA and the TFI provide South Africans with a genuine shot at improving the poor savings culture in the country. The combination of the two provides a realistic chance of your clients achieving a sustainable retirement over the course of a normal working life at affordable levels.

* Exceeding these limits will lead to a 40% tax penalty applied on excess contributions.