South African government is making huge strides in balancing the tax treatment of different retirement vehicles, however careful consideration should still be given to the different tax implications when choosing retirement savings products.
The 2013 FinScope survey indicated that the number of adults who do any saving at all is around 42%, with only half of those saving through formal channels.
The main retirement options, through formal channels, are compulsory pension and provident fund contributions, retirement annuities, pension and provident preservation funds, tax-free savings accounts, endowment and unit trust investments.
1. Pension, provident and retirement annuity funds
Pension and provident fund contributions are normally part of an employer and employee relationship, while retirement annuities are available to self-employed people, or those who want to supplement their existing pension or provident fund contributions.
Effective from 01 March 2016 tax deductions on contributions to retirement funds were harmonized. Tax deduction is capped at 27,5% on the greater of remuneration or taxable income. Contributions exceeding R350,000 per annum will constitute disallowed contributions. The disallowed portion will qualify as a roll-over on an annual basis until retirement, meaning that previous disallowed contributions can be added to the current tax-free lump sum of R500,000 at retirement.
Individuals with remuneration or taxable income less than R1,3 million per annum will be able to utilize the full 27,5% or R350,000 per annum cap. Most South Africans will be well within this cap, so it is quite a generous offer to encourage people to save.
Growth in pension funds, provident funds and retirement annuity funds are tax free.
Contributors to pension funds and retirement annuities may take one third of their retirement fund at retirement, however it is mandatory to reinvest the remaining two-thirds in a compulsory annuity. Any withdrawals at retirement exceeding the current lifetime tax free lump sum withdrawal of R500,000 plus any disallowed contributions will be taxed in accordance with the retirement lump sum tax tables (sliding scale).
2. Preservation funds
Pension or provident preservation funds are used to house accumulated savings at termination of employment (e.g. resignation, winding-up or retrenchment).
Funds transferred from a pension or provident fund to a pension or provident preservation fund are transferred tax-free. The growth in preservation funds are also tax free.
Withdrawal from a preservation fund will be taxed per the retirement lump sum or prior retirement lump sum withdrawal tax tables (sliding scales).
3. Endowment and unit trust funds
Endowment investment options are short-term investments with a fixed term, generally minimum of five years. Unit trust investments, however, are more flexible with no fixed term and investors have access to their funds at any time.
Contributions to endowment investment funds are made with after-tax money. Any interest, dividend income or capital gain earned in the fund is taxed in the fund. However, at the end of the five-year term, the proceeds are tax free.
Investors are taxed in terms of the five-fund tax approach where the income is taxed at 30% and capital gains taxed at 12%. Investors who is liable to pay income tax at the highest marginal rate might find that these type of investments is more tax efficient compared to a unit trust investment (not taking cost of the different products into consideration). It is very important to note that ending the investment before the upfront selected term could result in a penalty on a sliding scale.
Unit trust investors may access their funds at any time but the tax rates are not as lenient as with endowment investment funds. Normal rates for income and capital gains apply.
4. Tax-free savings account
This savings vehicle was introduced in 2015 and is also available as a supplement to existing savings.
Contributions are made with after-tax money, there is no tax in the fund and proceeds are tax free. Investors should however be wary of “over-contributions” as the penalties for doing so are “quite severe”. Individuals may contribute up to R30,000 per annum and up to R500,000 per lifetime. Contributions beyond these thresholds will result in a penalty tax of 40%, payable in the year of assessment in which the over contribution was made.