With the tax year-end coming up on February 28, now is your chance to take advantage of the tax break you receive if you put money into a retirement annuity. You need to sit down with your tax adviser to see what additional contributions you can make to qualify for the tax break.
According to Andre van Staden of Exord Payroll Solutions, a self-employed person can contribute 15% of income after expenses into a retirement fund. Many self-employed people whose income is erratic prefer to wait until year-end to do their retirement fund calculations and make a lump-sum contribution.
If you work for a company and are already part of a provident fund, Van Staden says there may still be an opportunity to take advantage of further tax-free retirement investments — although, again, one would need to confirm this with your tax adviser.
Most companies base their provident contributions on two-thirds of the employee’s total package. This leaves one-third of your salary that you can use to invest 15% tax free in an RA. Van Staden warns that this is only after travel and medical expenses have been deducted.
For example, a person earning R15 000 a month may have R5 000 of their income that has not formed part of the company’s provident fund calculation. After travel and medical expenses there is R3 000 left. The employee would be able to invest R450 a month of this into an RA and receive the tax benefit.
If you are looking to put some additional funds away for your long-term savings over and above your company pension, or you are self-employed and have not used your full retirement funding allocation, you need to weigh up whether you wish to do it from pre-tax or post-tax money.
By contributing to a retirement annuity you would be able to use pre-tax money and benefit from the tax saving. However, if you want to invest the money outside of RAs, you will have to use post-tax money.
For example, you earn R20 000 and are on a 35% tax rate, and you want to invest R1 000 in an RA. You would be able to deduct the R1 000 from your salary, leaving only R19 000 taxable income. You would pay R6 650 in tax, rather than R7000.
With the tax savings, your R1 000 savings costs only R350. If you paid from post-tax money you would not have the tax offset.
Retirement fund
Pros:
- The South African Revenue Service subsidises your contribution;
- Retirement products are exempt from capital gains tax; and
- It encourages self-discipline as you are unable to access your funds before the age of 55.
Cons:
- Even with the recent reform in the industry, retirement products carry additional charges that you can avoid if you invest directly into the underlying investments yourself;
- Legally, you can only gain access to your RA funds at the retirement age of 55, at which point two-thirds has to be invested in a life or living annuity to provide you with income — which is taxed; and
- The one-third lump sum that you are able to take is subject to a tax based on a formula and the income you receive from the annuity is also taxed. The bottom line is that while you receive a tax break up front, you will pay tax later.
Post-tax
Pros:
- A post-tax investment has no restrictions on when you can access the funds;
- You do not pay income tax on the proceeds; and
- You can invest your money anywhere you choose.
Cons:
- There are no initial tax savings; and
- You are liable for capital gains tax on the appreciation of your investment.
- If you do decide to go the post-tax route, one post-tax investment that makes a great deal of sense is paying the extra money into your bond.
Although you do not have the initial tax advantage, you are effectively receiving a guaranteed return equal to your mortgage rate. At current rates of 10,5%, that is a pretty good return. It also means you will pay off your house faster.
If you have a R1-million bond and you pay an additional R1 000 a month, you will pay off the bond in 14 years and save yourself a huge R442 000.