Tax benefits available through your RA and Tax-free investment
As we approach the end of the tax year 2022/2023, you have a few weeks left to take advantage of the tax benefits available through your RA and Tax-free investment account. Essentially, you can pay less tax while boosting your retirement nest egg or simply investing tax-free towards your goals.
Retirement planning can be quite an anxiety-provoking exercise, especially nowadays when inflation is sky-high, markets are volatile, and the cost of living is generally more expensive. With the amount of money, we put towards retirement savings whether it be a lump sum or a monthly contribution, you tend to wonder if it really is sufficient for you to retire. How long would you have to work to save just enough to retire comfortably, and is retiring comfortably even a reality for South Africans?
Saving for retirement looks a bit different for everyone. Some people are privileged enough to be employed in companies that contribute towards their retirement savings in the form of pension, provident, and umbrella funds. Others voluntarily contribute to their retirement savings through retirement annuity funds. Not all people want their money tied up in any retirement funds, perhaps due to access constraints, therefore they may just keep their money in the bank or have different types of investments that provide income.
Retirement Annuity (RA)
- Reduce your taxable income by increasing your retirement savings, which means you pay less tax now.
- Your contributions are tax-deductible. As an RA investor, you are able to invest up to 27.5% of your taxable income on a tax-deductible basis up to an annual maximum of R350 000, meaning that at the end of the tax year you can claim back the tax in respect of the contributions made towards your RA. Other than your salary, there are a number of other income sources that must be taken into account when calculating your taxable income including rental income, dividends earned from real estate investment trusts, and investment income. The tax benefit for contributions in excess of these amounts may roll over to the following tax year.
- In addition to being able to invest with tax-free money, retirement annuities are exempt from tax on dividends and interest, and no capital gains tax is payable on the growth earned in the investment.
- Retirement annuity investors are free to structure a portfolio that is wholly aligned with their objectives, investment horison, risk tolerance and requisite returns, and in doing so can select underlying funds and asset allocation that are fully customised to their needs.
- In addition, if a unit trust-based RA is used, investors can completely customise the way in which they contribute towards their RA which is especially beneficial for commission earners, those who are self-employed, and/or those who earn irregular incomes. Premiums can be set up to run monthly, quarterly, bi-annually, or annually, and can be stopped and/or started as per the investor’s wishes with no penalties being levied.
- With the earliest retirement age being 55, investors are not able to access their retirement funds prematurely, with the exceptions being in the case of ill-health and emigration which we discuss further below – and there is no age limit when it comes to retiring from an RA. As such, a retirement annuity should form part of a carefully constructed retirement plan that takes into account the tax implications of withdrawing from your RA, your future cashflow requirements, and any other retirement funding vehicles that you have in place.
- If you have plans to emigrate from South Africa, it is important that you understand what your relocation means for your retirement annuity. With effect from 1 March 2021, the concept of emigration for exchange control purposes has been phased out and, if you leave the country to take up permanent residence in another country, you will need to advise SARS that you have ceased to be a SA tax resident. In doing so, you will need to request a tax compliance status (TCS) for emigration before being permitted to transfer any funds abroad.
- That said, you will only be able to access the funds in your RA once you have not been a South African tax resident for an uninterrupted period of three years on or after 1 March 2021. The only other circumstance where you may be permitted to access the funds held in your RA prior to the age of 55 is in the event of early retirement as a result of ill-health or disability, although you will need to meet the criteria of permanent disability as set out in the fund rules in order to qualify.
Unlike the old, insurance-based RAs, new generation retirement annuities are flexible, transparent, highly customisable, and cost-effective, and remain one of the most attractive options for long-term retirement investing.
Tax-free Investment (TFI)
- Maximise the growth on your investment as the interest, capital gains and dividends you earn are completely tax-free, except for Foreign Dividends.
- You can invest R36 000 per tax year up to a lifetime maximum of R500 000. If you contribute more than these maximums, penalties will be incurred.
- Tax-free investments were introduced in 2015 to encourage South Africans to save more. This means that you are not liable for any capital gains tax, dividends withholding tax or tax on the interest received. However, keep in mind that your contributions towards your TFSA are made with post-tax money meaning that no tax deduction is available on your contributions as is the case of retirement fund contributions. With this in mind, it makes sense for investors to first ensure that they are contributing adequately to a retirement fund to minimise their taxable income before taking out a TFSA.
- Legislation allows you to invest up to R36 000 per year towards a TFSA, or R3 000 per month, with the maximum lifetime contribution being R500 000. Most product providers make allowance for a minimum monthly contribution of R500, with the option of making monthly or annual contributions, or even ad hoc contributions as and when the opportunity arises. You should not invest more than the maximum of R36 000 per tax year and R500 000 over your lifetime across all your tax-free products combined. If you do, you will pay a tax penalty of 40% of any amount over this limit.
- To benefit from compound interest, avoid withdrawing your savings early. – You can’t top up or replace any funds you withdraw from your tax-free savings and investments because it already counted towards your annual and lifetime contribution limits. For example, if you’ve saved R200 000 and you withdraw R100 000, your lifetime contribution will now be R200 000. This means you’re only allowed to save another R300 000 tax free in your lifetime.
- When setting up your TFSA, give careful thought as to how you intend to use the proceeds in the future and then choose an investment portfolio that is aligned with your timeline. For instance, you may wish to use it as a savings vehicle for your newborn child’s tertiary education, in which case your investment horizon is approximately 18 years. On the other hand, if you want to use it to supplement your retirement funding, you may be looking at a longer time period. Either way, if you’ve taken a long-term view on your TFSA, consider having a higher allocation to growth assets and less allocation to cash and fixed income which are poor long-term investments.
- Even though no tax is payable on the earnings within a TFSA, as a South African tax resident you are required to disclose all investment information to Sars when submitting your annual tax return, including certificates issued for income within your TFSA.