End of the financial year Retirement Annuity and TFSA contributions

Retirement Annuity Contributions

Generating real wealth requires using the few tax allowances available to advance financially.

Retirement annuities are well-known for their tax-deductible contributions. However, the tax benefits are far more comprehensive than just this.

In this 8^th edition article which you can find here, I compare using this strategy against investing in anything else.

First, you will get more in "what else you want to invest also" by using this allowance! (And then investing the tax savings and balance towards anything else, like settling debt, investing offshore or investing in property). If it sounds too good to be true, I'll give an example to illustrate the effects.

If you want to apply more cash to your financial goals, this is one way to help achieve these.

For every R100 invested in an RA, you will immediately receive R45* back in Income Tax and later save R20 in Estate Duty and just over R4 in executors fees. You will also not be paying Income Tax, CGT or dividend taxes in the build-up within the RA (these taxes are not a once-off, but rather an annual event otherwise).

*assuming a 45% marginal tax rate.

The other point is that this allowance needs to be more fair and equitable. It grossly favours the higher earners. The more you earn, the more beneficial it is!

So much so that there's minimal tax incentive for people who earn less.

Many individuals, especially business owners and contractual employees whose income can fluctuate substantially, prefer to ensure positive cash flows during the year. Making lower regular monthly contributions and adding additional lumpsum contributions before the end of the tax year (more commonly referred to as "RA top-ups").

The final analysis, subject to cash flow, means paying funds to SARS or yourself. I say, look after yourself first.

Your provisional tax returns due at the end of February are always an opportune time to re-evaluate your RA contributions for the year.

The allowance is so advantageous for higher earners. SARS, therefore, caps the maximum rand value at R350 000 per annum.

All members are now allowed the deduction for total contributions to approved retirement funds of 27,5% of the greater of their remuneration or taxable income, subject to an annual maximum of R350 000 – and any unused deductions may be rolled over to subsequent tax years.

(This practice of a maximum capped allowance has existed in most Western countries for many years. However, in the UK, there's a lifetime absolute cap in place of 1 million GBP and an annual limit. (This has reduced over the past few years).

I have recently been asked whether one can claim RA contributions against Capital Gains. Previously, one could, but this changed in the 2019 legislation where this is no longer allowed.

I shared further details on page 4 of the attachment. Investors have the remainder of this month to "top-up".

Once you are over 55, Reg28 no longer applies if you transfer to a Living Annuity.

Since 6 January last year, retirement funds have been allowed to invest in infrastructure projects. SA was previously behind international norms, where Pension Funds overseas most often have exposure of around 10% in this asset class, diversifying slightly out of only traditional share m. We in SA need to catch up where the investment case makes sense.

Once you reach age 55, you can retire from your RA and Regulation 28 is no longer enforced (although this remains a suggested guideline). You can invest 100% of your assets offshore within a Living Annuity.

Tax-Free Savings Accounts (TFSAs)

The government introduced tax-free savings accounts on 1 March 2015.

All growth and interest on investments through these accounts are entirely tax-free. Therefore, there is no Capital Gains Tax, Dividends Tax or Income Tax from interest earned in the build-up of these funds.

Most existing unit trusts, exchange-traded funds, savings accounts, fixed deposits and savings bonds already meet the requirements to be classified as a TFSA.

In other words, these investments are familiar products.  Instead, SARS will treat them as separately stated stand-alone investments. Therefore, product providers must record these to separate them from your other investments.

You can invest R36 000 per year into a TFSA subject to a maximum lifetime limit of R500 000.

SARS will charge you tax on contributions above these thresholds. Therefore, you certainly don't want to over-invest here.

If you withdraw money from the TFSA, you will lose the value of that withdrawal from your lifetime limit - which means you should only use the TFSA for long-term investments (20 years and longer). But you are not forced to keep your money in a TFSA. You are allowed to withdraw at any time with no penalties or tax.

How does a TFSA fit into the overall planning

To prioritise your long-term savings, a sensible order would be :

1. First, pay off your short-term debts,

2. Then build up an emergency reserve not in a TFSA, equal to 3-6 months' worth of expenses, followed by

3. Making full use of your retirement fund contribution allowance (27,5% of taxable income with a maximum cap of R350 000 per annum) and

4. Only then investing R36 000 per person in a TFSA,

5. Followed by your normal discretionary voluntary longer-term savings in unit trusts.  

Where else can this be useful?

• Additional savings for retirement after the changes last year saw the tax deduction to formal retirement funds being limited to R350,000 per annum. The Minister thought this structure would give a little further benefit to high net-worth individuals.

• You may want to make provision for a possible retrenchment. Again, the structure lends itself to the idea that if you need the funds, you can use them, but these long-term savings can then be added to your retirement provision if not required.  

· Similarly, as with retirement funds, beneficiaries may be nominated on the TFSA. In the event of the contract owner's death, the investment will be paid out to the designated beneficiaries, leading to savings in the executor's fees and quicker access to the proceeds.

· Younger persons will benefit from TFSA, which will take at least 15 years to reach your lifetime allowance. However, the benefits of allowing the capital to grow without tax over the long term can be significant over time.

If you are an older investor or will only be investing your money for a short period, the benefits of TFSAs are less noticeable.

However, investors in the higher income tax brackets should use the TFSA because they will save on tax. Over the past few years, the Minister has indicated that he would NOT be increasing the interest exemptions (R23 800 pa for persons under 65 years of age, and R34 500 pa for persons over 65).  

For persons over 65, the interest exemptions are still in place at this stage. You’ll need to have more than R430 000 (per individual), meaning you and your spouse could each have this amount) in a Money Market Fund before exhausting this allowance.

I remain unconvinced that this new account is the compelling incentive for lower earners to change their saving patterns to save more. On the other side, wealthy individuals who don't have liquidity requirements can get the same tax benefits on the growth in a retirement annuity for an unlimited-size investment).  

Disadvantages to consider

• These accounts are not protected from creditors like Retirement Annuities are (in the event of insolvency).

• You can't claim your contributions back from tax like you can with other formal retirement funds.

• They also form part of your estate for estate duties when you pass away.  

Implementation

We have calculated that the tax savings are minimal, especially early on.

It's the tax savings only, on the interest of the R36 000 investment.

It is not a tax deduction of the R36 000 per person per annum itself.

Then, given that you should refrain from withdrawing funds (as you permanently lose the benefit), you probably don't want to be invested in money markets.  

Many retail and private banks initially ran advertisements to use their money market funds for these investments.  If the lifespan is at least 16 years, having savings this length of time in the money market is simply ridiculous. With this timeframe, it should be fully equity-based. Therefore, you will save a bit of CGT later, but that's about it.

Therefore, TFSAs should be done to negate the eroding effect of the interest exemption eroding to inflation over time, but it's a highly long-term call.

Underlying investments that would be attractive in a TFSA include listed property where the rental income is usually taxed as interest in an individual's hands but is tax-free within a TFSA. In addition, should the Rand weaken, offshore investments will also benefit in a TFSA, as the currency gain will not be subject to CGT.     

A further aspect of the underlying funds is that investment funds charging performance fees cannot be accommodated in a TFSA. As a result, some funds, like Emerging Market funds, have few options in the marketplace to include these in a TFSA, and other funds have had to introduce a separate class fund only to be included in TFSAs.         

Leading product options

Old Mutual Wealth and Investec are the two options I believe are the best options.

Both have a simple, efficient offering and a good costing structure.

The only other difference then comes down to investment fees at the product level. The OMW proposition of client-based costing, all existing investors in OMW "who have a recurring investment of R2 500 pm in place, the usual minimum fee of 0,34% pa subject to a minimum rand value will NOT apply, as long as the monthly recurring investment is in place". (looking at investment fees through your different investments (UTs, RAs, Life Wrappers, etc.) as a whole),

"The minimum fee will also NOT apply (in the case of lumpsum investments) if the client has an existing OM Wealth investment in place".

So, in other words, existing OMW investors with over R2,4 million investments effectively get a zero administration product fee.

Using Investec, the fees will be the same as their regular fees, which, after Rnil cost offerings, are the best the industry can offer.

Regarding our analysis, these are the best product offerings available, and for further information, you are welcome to contact me for further details.

Friday Food For Thought