The tax benefits of investing through a retirement fund structure are hard to ignore and, as such, formal retirement funds such as pension, provident, preservation and retirement annuity funds make for attractive options when saving for retirement. The Taxation Laws Amendment Act, which aims to simplify the retirement funding landscape, has been successful in bringing these vehicles and their tax treatment into alignment. Following the harmonisation process which took effect 1 March 2021, it is now easier for investors to understand how to save for retirement and how each vehicle works.
Pension funds are generally offered as a condition of employment. Upon joining a company, employees may be required to join the company’s pension fund towards which they will contribute on a monthly basis. Employees are given the option of selecting at which level they would like to contribute and may be given the option of increasing their monthly contribution, up to certain limits. Depending on the structure of the fund, the employer may make a contribution towards the employees’ pension fund as part of their employee benefits. As is the case with all retirement funds, up to 27.5% of one’s taxable income can be invested towards a retirement fund structure on a tax- deductible basis, subject to an annual limit of R350 000. The retirement fund is managed by a board of trustees whose responsibility it is to govern the fund in compliance with the Pension Funds Act, the Income Tax Act, and other related legislation. As part of their duties, the fund trustees are required to set the investment strategy, bearing in mind that they may provide various investment options for the members. For instance, they may decide to include a more conservative investment strategy for those members who are close to retirement, while providing a more aggressive strategy for those members with a longer investment horizon. Being a retirement fund, the funds are subject to Regulation 28 of the Pension Funds Act which aims to limit the investment risk that retirement funds are exposed to.
Where a member leaves his employment, he has the option to leave his accumulated capital in the employer’s default investment strategy until he retires. He also has the option of transferring the funds on a tax-neutral basis to a retirement annuity in his own name or a preservation fund. While not advisable in most circumstances, the member may choose to make a part or full withdrawal of his funds which will be taxed according to the retirement withdrawal tables. The earliest age at which a member can retire from a pension fund is age 55, although the formal retirement age will be dictated by the scheme’s rules. At retirement, a member has the option to withdraw one-third of the fund value which will be subject to the retirement fund tax tables. The remaining two-thirds must be used to purchase an annuity income in the form of a life annuity, living annuity or hybrid. If the member chooses not to take a one-third withdrawal, they must use the full amount to purchase an annuity income. Bear in mind that where the value of the fund at the date of retirement is less than R247 500, the member is able to withdraw the full amount, subject to tax.
Similar to pension funds, a provident fund is normally offered as a condition of employment where a person joining an employer group is required to contribute a portion of their income on a monthly basis to the company’s provident fund. The tax deductibility of provident fund premiums are fully aligned with pension fund contributions which means that members can invest up to 27.5% of their taxable incomes towards the fund and claim a tax deduction from SARS. When leaving employment as a result of retrenchment, resignation or dismissal, the member similarly has the option of withdrawing the full amount accumulated in the fund, or transferring the capital in full or in part to a preservation fund or retirement annuity. As is the case with pension funds, provident funds are managed by a board of trustees who similarly perform the function of choosing an appropriate investment strategy (or strategies) for the provident fund members.
Prior to the implementation of retirement fund harmonisation on 1 March 2021, members retiring from a provident fund had the option of making a full withdrawal from the fund with no restriction on what they could use the funds for. The withdrawal rules for provident funds have now been changed to bring them into alignment with pension funds and retirement annuities. However, it is important to note that provident fund members’ existing rights have not been affected and only those funds invested after 1 March 2021 will be subject to this new ruling. In practice this means that all savings that have accumulated as at 28 February 2021 will be subject to the old rules and those aged 55 on 1 March 2021 will still have the option of full withdrawal on retirement provided they remain in the same employer fund, including those funds that accumulated subsequently. However, where a member leaves and joins a new provident fund, his new savings will be subject to the new rules and full withdrawal will not be an option for the funds accumulated in his new provident fund.
Those members who are younger than age 55 on 1 March 2021 will effectively have two separate retirement savings, with the first being those funds that accumulated up to 1 March 2021 plus all future investment growth (referred to as vested rights), and the second being those that accumulated after 1 March 2021 including all investment growth. When the member retires from the provident fund, he has the option to make a full withdrawal in respect of his vested rights, subject to tax. The unvested rights, being those that accrued post-1 March 2021, will be subject to the same withdrawal rules as pension, preservation, and retirement annuity funds. As in the case of pension funds, where the fund value at retirement is less than R247 500, a full 100% can be taken at retirement, subject to tax.
Preservation funds are specifically designed to preserve accumulated capital, which is intended for retirement, and make an attractive option for those leaving employment through retrenchment, resignation, or dismissal. While their withdrawal rules are aligned with pension funds and the new provident fund ruling, there are a number of features that make preservation funds unique. When a person leaves their employment through resignation, dismissal, or retrenchment, they have the option to withdraw the full amount of their accumulated funds and will be taxed accordingly. However, first prize is to keep the capital invested so as not to interrupt the process of compounding and to protect the growth achieved in your investment. The preservation fund is designed for exactly this purpose and, being a retirement fund, is regulated by the Pension Funds Act and the provisions of Regulation 28. When leaving employment prior to formal retirement, you have the option to preserve your accumulated capital by transferring it tax-free to a preservation fund. Once your money is housed in a preservation fund, you are not able to make additional contributions to the fund unless the money originates from a registered retirement fund. Unlike pension and provident funds, investors are permitted to make one full or partial withdrawal from their preservation fund prior to the age of 55, with only the first R25 000 being tax-free. At retirement, the withdrawal rules are the same as the case of pension funds and the new provident fund legislation. This means that investors can opt to commute one-third of their accumulated capital subject to tax, with the remaining two-thirds used to purchase an annuity income.
Where one’s employer does not make provision for a pension or provident fund, or where a person is self-employed, a retirement annuity provides an excellent vehicle for retirement investing. Investors can choose to either invest through an insurance-based or unit trust-based retirement annuity, with the latter being preferable as they provide greater investor flexibility, more transparent fee structures, and do not penalise investors if they stop contributing. The tax deductions available to investors are the same as for pension funds and provident funds, allowing you to invest up to 27.5% of your taxable income towards your retirement annuity up to a maximum of R350 000 per year. Contributions to a unit-trust based retirement annuity can be made monthly, quarterly, annually or on an ad hoc basis, and investors can stop and start their contributions as and when their circumstances change. Investors have full freedom to choose an investment strategy that is fully aligned with their needs, albeit within the constraints of Regulation 28. The investment flexibility and choice available to individual investors make retirement annuities particularly attractive. Keep in mind that retirement annuity funds cannot be accessed before age 55 and, unlike pension and provident funds where retirement age is regulated by the scheme rules, investors are able to formally retire from the fund at any stage thereafter. However, the same one-third, two-third withdrawal options are available to retirement annuity investors upon formal retirement to ensure that the bulk of the funds are used to purchase a pension income.
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