Retirement funds
Retirement funds are highly tax efficient as contributions, including those from employers in group retirement funds, are tax deductible up to 27.5% of taxable income, capped at R350 000 annually. Furthermore, there’s no capital gains tax, dividends withholding tax, or income tax on investment growth within retirement funds, encompassing pension, provident, and retirement annuity funds.
Accessing capital from pension and provident funds before retirement is currently restricted to instances of resignation, dismissal or retrenchment. Retirement annuities allow early withdrawal only in cases of permanent disability or breaking of tax residency, subject to a 3 year waiting period, before age 55. It’s therefore important to understand that retirement funds are long-term commitments because, upon retirement, at least two-thirds of the funds must be used to purchase annuity income, such as a life annuity, living annuity, or a combination thereof. While these rules may seem restrictive, they are designed to safeguard retirement savings, prevent premature depletion of funds and ensure a secure financial future.
From a tax perspective, if you choose to take a cash lump sum from your pension or provident fund on resignation, dismissal or retrenchment, you will be taxed according to the following withdrawal table, cumulatively over your lifetime:
Taxable income (R) Rate of tax
1 – 27 500 0% of taxable income
27 501 – 726 000 18% of taxable income above 27 500
726 001 – 1 089 000 125 730 + 27% of taxable income above 726 000
1 089 001 and above 223 740 + 36% of taxable income above 1 089 000
At retirement, should a portion be taken as cash up to a maximum of one-third, you will be taxed on the retirement tax tables cumulatively over your lifetime:
Taxable income (R) Rate of tax
1 – 550 000 0% of taxable income
550 001 – 770 000 18% of taxable income above 550 000
770 001 – 1 155 000 39 600 + 27% of taxable income above 770 000
1 155 001 and above 143 550 + 36% of taxable income above 1 155 000
Unit trusts
Unit trust portfolios offer significant investment flexibility but are less tax-efficient, potentially subjecting investors to income tax on interest earnt, capital gains tax, and dividend withholding tax depending on portfolio management. Interest earned, both locally and abroad, is taxed at the marginal rate, and dividends are subject to a 20% withholding tax on South African resident and JSE-listed foreign companies. Individuals under 65 enjoy tax exemptions on up to R23 800 of local interest, while those over 65 can exempt up to R34 500. Switching or withdrawing from unit trusts triggers capital gains or losses with the first R40 000 of gain being tax-exempt annually and thereafter 40% of any gains above this exemption are included in your taxable income and taxed at your marginal rate. Despite the tax implications, unit trusts remain popular for their investment flexibility, allowing diversified portfolios tailored to individual risk profiles and investment goals.
If you have invested indirectly offshore through a Rand-denominated fund, you will be liable for tax on all gains generated from either capital growth and or currency movement, as well as tax on foreign interest and dividends at 20%. On the other hand, if you’re invested directly through an offshore platform, no tax is paid on gains made as a result of currency movement. A unit trust portfolio can play an important role in one’s discretionary portfolio when it comes to creating liquidity, diversifying one’s portfolio, saving for pre-determined goals, and investing more aggressively. However, it is important that you take into account the potential capital gains tax consequences of selling or switching unit trusts so as to avoid unnecessary costs which can negatively impact on your investment returns.
Tax-free savings accounts
Tax-free savings accounts (TFSAs) offer a compelling blend of tax efficiency and investor flexibility, although they aren’t ideal for short-term savings due to contribution limits and penalties for over contributions in each tax year. The key advantage of TFSAs lies in tax-free growth: all interest and dividends earned within a TFSA are exempt from tax, and no capital gains tax is levied upon withdrawal. This enhances potential returns compared to standard unit trusts.
Annual TFSA contributions are currently capped at R36 000, with a lifetime contribution limit, currently R500 000, ensuring tax-free status is maintained, and exceeding these limits incurs a 40% tax. Therefore, monitoring contributions is crucial, especially if you have multiple TFSA accounts. While TFSA tax benefits are significant, integrating them into a broader investment strategy is advisable. Prioritising contributions to retirement annuities and utilising annual tax-free interest exemptions (currently R23 800 per year) before maximising TFSA benefits can optimise overall tax efficiency and savings growth. This strategic approach ensures that TFSAs serve as effective long-term savings vehicles within a comprehensive financial plan.
Endowments
Endowments also offer tax benefits to investors with a marginal tax rate of more than 30% as they effectively reduce the tax payable on investment growth. However, they require a minimum investment term of five years, allowing for one withdrawal during this period, albeit with potential penalties. Contributions to endowments are made with after-tax money, whether as lump sums or regular payments.
Endowments are taxed at a fixed rate of 30% in the hands of the life company, making them more tax-efficient than unit trust investments for higher tax brackets. They also facilitate estate planning by allowing investors to nominate beneficiaries, ensuring prompt payment without estate delays nor executor fees. It’s important to note, however, that the proceeds of endowment policies are considered deemed property in a deceased estate and may be subject to estate duty.
Endowment investors enjoy flexibility in fund selection, with options for local or offshore endowments tailored to specific financial goals. Platforms also offer the freedom to switch between funds, thereby enhancing investment adaptability. Choosing the right endowment structure depends on individual tax planning needs, investment horizon, and estate objectives, ensuring optimal wealth management and legacy planning.
As is evident from the above, the interplay between tax and investment returns can be complex, and tax saving should not be the only goal to the exclusion of other objectives.
Have a super day.
Sue
