By Natalie Kiewitt
Investing for retirement through a retirement annuity (RA) is an effective and rewarding way to save for retirement because of the unique benefits offered. The most significant benefit is the fact that you can enjoy unparalleled tax savings.
Maximising the tax benefit
With an RA, you can contribute monthly or as a lump sum before the end of each tax year up to the limits set by SARS. The current tax year ends on 28 February 2022, and you can contribute up to 27.5% of your annual taxable income, subject to a maximum tax deduction limit of R350 000 per year. The tax deduction limit applies to your cumulative annual retirement contributions, regardless of whether you saved in an RA, a pension fund, or a provident fund.
SARS will not penalise you for contributions that exceed the allowable limits. The tax benefit can be carried forward to reduce tax liability in future tax years if you exceed the 27.5% maximum contribution limit. Ultimately, the more you top up your RA contribution for the tax year, the higher the tax benefit.
In addition to the tax-deductible premiums, RAs are exempt from tax on dividends and interest, and no cgapital Gains tax is payable on growth earned in the investment.
The tax benefits extend to when you reach retirement, where you can make a withdrawal, which can be up to one-third of your investment as a lump sum and where the first R500 000 is tax-free. Any lump sum withdrawal exceeding the R500 000 tax-free portion will be taxed according to the retirement tax tables. If you have more than one RA or other retirement savings vehicles, the withdrawal limit applies to your total retirement savings.
Further benefits of an RA
Not only does an RA offer tax benefits, but it is designed to provide a structured approach to saving towards retirement over time, along with features to help safeguard retirement savings.
One of the features of an RA is that your retirement savings are protected from creditors. This means that if you are declared insolvent, creditors are not allowed to access your retirement funding. Furthermore, your RA benefit is not subject to estate duty, allowing you to support your dependents and provide for those you leave behind.
Proof that RA top-up pays
The biggest advantage of topping up your RA is that you will have boosted your retirement savings over the long-term, and the power of compound interest really takes full effect over time. You can further boost your retirement savings by reinvesting the tax rebate received from SARS, when you include your RA contributions in your tax return.
To show the impact of topping up, let’s look at the graph. An investor earns an annual salary of R500 000 and contributes 7.5% of taxable income into her retirement annuity. She earns an annual bonus of R100 000.
In one scenario, she does not top up her RA and in the other, she uses 30% of her bonus for the RA top-up.
The result is that after 15 years, her retirement savings grew by 80% more when compared to the scenario where she did not top up.
Deciding not to top up your RA in favour of having more disposable income can be tempting but in the long run the benefits of topping up your RA far outweigh the decision not to.
More opportunity for tax savings
If you’ve taken advantage of all the tax benefits available through RA contributions, consider a tax-free investment that can help you reap even more tax benefits and bolster retirement savings.
Offering an investment option with zero tax on investment income or growth and no dividend tax, you can invest up to R36 000 per tax year until you reach the lifetime limit of R500 000.
While a tax-free investment is not designed to be your sole source of retirement savings, it presents an opportunity to boost your nest egg with a lump sum. The tax-free investment is not subject to Regulation 28 (part of the Pension Funds Act) which limits the percentage allocated across assets or asset classes offering more freedom around choosing investment options. It’s important to note that if you exceed the annual or lifetime limit there are significant tax penalties that could erode the value of your investment.
As we approach the end of the tax year, you have a few weeks left to take advantage of the tax benefits available through your RA and tax-free investment account. Essentially, you can pay less tax while boosting your retirement nest egg or simply investing tax-free towards your goals.
Natalie Kiewitt is Executive of Operations at PPS Investments