For the purposes of this exercise, we have used the example of two investors, Boipelo and Sam, who are both age 35. They both earn an income of R60 000 per month, netting an amount of R43 196.75 per month after tax in accordance with the current tax tables. Both Boipelo and Sam are able to invest an amount of R15 000 per month.
Boipelo chooses to invest her R15 000 per month towards a unit trust-based retirement annuity, whereas Sam elects to invest into a discretionary unit trust portfolio. In preparing the examples below, we have assumed that real investment returns for both Boipelo and Sam are set at inflation plus 4%. For a list of all further assumptions made in preparing this analysis, please see below.
The wealth accumulation phase
(i) Boipelo’s investments
Because Boipelo invests an amount of R15 000 per month towards a retirement annuity, she receives a tax refund from SARS every year of R67 992 1. To boost her retirement savings and to ensure liquidity in retirement, Boipelo invests this refund every year into a discretionary unit trust portfolio. After 30 years, her investments in today’s terms are as follows:
| Boipelo’s investments in 2051 | |
| Retirement annuity | R9 902 2522 |
| Discretionary unit trust | R3 834 9753 |
| Total savings | R13 737 227 |
(ii) Sam’s investments
Sam invests his R15 000 per month into a discretionary unit trust portfolio and does not receive any tax rebate. After 30 years, he has the following amount in today’s terms invested:
| Sam’s investments in 2051 | |
| Retirement annuity | R0 |
| Discretionary unit Trust | R9 902 2524 |
| Total savings | R9 902 252 |
At retirement, Boipelo has 39% more in her investments than Sam.
At retirement
At retirement, Boipelo is permitted to withdraw up to one-third of the capital in her RA. She is obligated to purchase a compulsory annuity with the remaining funds. She can also elect to use the full amount to purchase a living annuity.
(i) Boipelo’s investments
To be tax-savvy, Boipelo elects to only withdraw R500 000 from her retirement annuity tax-free and re-invest these funds into her discretionary unit trust portfolio today. She purchases a compulsory living annuity with the balance remaining in her RA. Her investments at retirement are therefore as follows:
| Boipelo’s investments in 2051 | |
| Living annuity | R9 402 252 |
| Discretionary unit Trust | R4 334 975 |
| Total savings | R13 737 227 |
As Boipelo is age 65 at retirement, she only pays tax on the amount over R11 262.50 per month. Taking her objectives into account, Boipelo would need to draw R68 750 pre-tax in order to receive an after-tax income of R50 000 per month in today’s terms from her investments. This income will increase annually at a rate of 5% to keep pace with inflation, and the capital would be exhausted by age 100, without experiencing any liquidity problems.
*Drawdown calculations are modelled in retirement funding and drawdown tool where all taxes are calculated on the current SARS tax tables.
(ii) Sam’s investments
Because Sam has invested in a discretionary portfolio, he is not obligated to purchase a living annuity. His funds therefore remain in his unit trust portfolio:
| Sam’s investments in 2051 | |
| Living annuity | R0 |
| Discretionary unit trust | R9 902 252 |
| Total savings | R9 902 252 |
Sam has less invested capital than Boipelo, and in order for his capital to support an income until age 100, he would only be able to draw R42 000pm as a post-retirement income in today’s terms, increasing annually at a rate of 5%. We have assumed that Sam’s portfolio is structured in order to minimize paying tax on interest earned, dividend’s tax and CGT.
*only interest earned above R34 500 threshold will be included as taxable income, and in a balanced fund there is limited exposure to income generating assets classes, and capital gain is only applicable on disinvested units. With no other income, it will be highly unlikely that the drawdown leads to significant income tax being paid.
The advantages of Boipelo’s RA
After 30 years of equal investment premiums, Boipelo will have amassed 39% more in invested capital than Sam. Because Boipelo has made optimal use of her retirement annuity over a 30-year period, she is able to draw 19% more after-tax retirement income than Sam. This example demonstrates how the mechanics of a retirement annuity, if used as a long-term investment vehicle, can benefit an investor as follows:
- The investor can save tax by investing into an RA and benefiting from higher SARS tax rebates;
- At retirement, the investor is permitted to withdraw R500 000 tax-free from her RA, which also benefits the investor by creating future liquidity;
- Interest and dividend income earned by retirement funds are exempt from taxation
- Members interest in retirement funds are exempt from Estate Duty, making them effective estate planning vehicles.
Conclusion
In conclusion, the main reason Boipelo is significantly better off using a retirement annuity rather than Sam using a discretionary investment has to do with the difference in the average tax break an investor enjoys on contributions and the average tax rate at which one is taxed on withdrawals. Her Contributions are deducted at Boipelo’s maximum tax rate being 39% on the bulk of contributions, and 36% on the remainder, resulting in an average tax break on contributions of 38%. Once she retires, the income she draws is taxed on a progressive basis with the first R11 262.50 being tax- free and the balance taxed progressively as per the tax tables resulting in her paying an average tax rate of 26%.
Assumptions
* CPI is assumed at 5% per year
* Investment premiums will increase annually at a rate of 5%
* SARS tax rebates from retirement annuity contributions will increase annually at a rate of 5%
* For the sake of simplicity, we have assumed real investment returns on all invested assets to be inflation plus 4%
* Life expectancy of age 100 is assumed
* Personal tax rates as per the 2021/2022 tax tables apply
* Retirement age of 65 is assumed
* We have assumed that the investment premiums will escalate per annum in line with inflation
* We have assumed no tax bracket creep over the investment period
