You must take the effects of tax into account at every stage of your retirement planning, Jenny Gordon, senior legal adviser at Old Mutual, told the Personal Finance/Old Mutual Retire Right seminars held recently around the country.
Tax should never be a driving factor in your investments, Jenny Gordon, senior legal adviser at Old Mutual, says.
Gordon gave five guidelines for structuring your retirement right for tax:
- Don't allow tax to be a driving factor - "tax concessions encourage us to save for retirement, but must not be seen as an end in themselves", she says;
- Make retirement decisions based on existing tax rules - don't speculate about possible changes;
- Regardless of tax changes, keep investing - remember your goals;
- Take remedial action if tax changes affect the end result you planned. "Paddle harder in the rapids"; and
- Remember that structuring your retirement right for tax starts long before retirement.
At every stage there are tax planning possibilities. "But they must never been seen in isolation from your overall retirement strategy," Gordon says.
There are four stages at which you should engage in active tax planning: When you contribute to a fund; while your investment in the fund is growing; when you leave the fund (through resignation, retirement or death); and when your income is taxed into retirement.
When saving for retirement, you can save in compulsory pension, provident or retirement annuity funds where contributions are made with pre-tax money, or in voluntary investments where contributions are made with after-tax money and proceeds have traditionally been tax-free.
With the introduction of capital gains tax (CGT) on October 1 many of these investments will no longer be tax-free, but many people will still need to top up retirement savings intermittently and especially in the last lap before retirement, Gordon says. "So most of us will have a combination of voluntary and compulsory savings."
In deciding on tax savings, you must ask whether you are simply postponing your tax payments or whether you are really saving on tax. "If tax will merely be postponed, maybe you should consider after-tax investments with tax-free payouts such as endowments. However, the compound growth of pre-tax money in an investment over a long period often compensates for tax payable at the end. And in retirement your marginal rate of tax will probably be lower than in your working years," Gordon says.
There are two categories of pre-tax funds: Employer-based investments such as pension or provident funds, and retirement annuities.
Retirement funds
Characteristics of employer-based investments are:
- Employers can deduct 20 percent of remuneration from tax;
- Pension fund members can deduct 7.5 percent of remuneration or R1 750 a year tax-free;
- Employee contributions to a provident fund are not tax-free;
- Pension, provident and retirement annuity funds pay 25 percent of gross interest, net rentals and foreign dividends in tax;
- Current indications from the government are that these funds will pay no CGT in the next three years, pending a revision of retirement fund tax; and
- On retirement from a pension fund you can take one third in cash and two-thirds must be used to purchase a pension; on retirement from a provident fund you can take all your money in a lump sum or you can purchase an annuity.
Part of the cash withdrawal from pension and provident funds is tax-free, but just how much depends on how long you have worked. In order to withdraw the maximum R120 000 tax-free, you must have been contributing for 20 years, Gordon says.
You will be taxed on the balance at your average tax rate.
Once you are retired, the income from your annuity is taxed at your marginal rate.
Retirement annuities
Characteristics of retirement annuities are:
- You can deduct either 15 percent of your non-pensionable earnings (not including allowances) or R3 500 a year less your deductible pension fund contribution or R1 750 a year;
- Unlike pension and provident funds, retirement annuity funds can be invested fully in equities and it is possible to pay no tax on the build-up in the fund; and
- At retirement age you can withdraw R120 000 of the lump sum tax-free - regardless of how long you have been contributing.
When you retire you must use two thirds of your money to purchase an annuity, either a conventional or a living annuity.
The capital of a living annuity is invested in the insurer's portfolio and you can get tax-free growth on the build-up. This means that later into retirement you have a larger capital base from which to draw an annuity, if in the first years you take a smaller annuity than the capital growth.
The income you draw is fully taxable, but, Gordon says, tax rates at retirement are generally lower than during employment. Over the age of 65, the tax threshold is R39 154; the interest exemption is R5 000 and medical aid contri-butions are fully deductible.
A medical aid contribution of R15 000 a year will raise your annual tax threshold to R60 000 or R5 000 a month. This allows R55 000 tax-free annuity income - a good reason to save via retirement funds, Gordon says. "Retirement annuities make excellent post-retirement medical aid funding vehicles."
Preservation funds
Preservation funds are an "outstanding" vehicle for retirement planning, Gordon says.
The main benefit of these funds - which enable you to "park" your money when you leave a job before retirement - is the single withdrawal you can make before retirement. If you contribute to a pension fund, leave your job and park the money in a preservation fund, you can withdraw R120 000 tax-free at age 55 - provided you have been contributing to the pension fund for 20 years. If not, your tax-free withdrawals are lower.
Any withdrawal will reduce your tax-free portion at retirement.
If you withdraw any money when you leave employment, you can only park it in a retirement annuity fund. But there you will get your R120 000 lump sum tax-free.
You have to retire from your preservation fund when you retire from your current employer.
How much tax you pay
Life assurance
You pay no tax: The life office pays 30 percent on net income; 7.5 percent in capital gains tax (CGT).
Bank depositsYou pay tax at your marginal rate on interest - less the R4 000 exemption on interest income for people under 65 and R5 000 for people over 65.
Unit trustsYou pay tax at your marginal rate on interest and up to 10.5 percent in CGT; dividends are tax-free.
Wrap fundsYou pay your marginal rate of interest and up to 10.5 percent in CGT.
Domestic equitiesYou will pay up to 10.5 percent in CGT. Dividends are tax-free.
Offshore endowmentsYou will pay up to 10.5 percent in CGT.
Offshore unit trustsYou pay your marginal tax rate on interest and foreign dividends - less the R4 000 or R5 000 exemption; up to 10.5 percent in CGT.
PropertyYou pay your marginal tax on rentals and on interest - less the exemption on the interest portion; up to 10.5 percent in CGT on the sale of the property.
Your own businessDepends on many factors.
Bonds
You pay tax at your marginal rate on interest, less the exemption.
Start young for a carefree retirement
It might sound silly to start your retirement planning the day you get your first salary cheque, but that's how to make sure your retirement is carefree, Kobie Taljaard, the human resources director at the Cape Technikon, says.
Addressing the recent Retire Right seminars, Taljaard says retirement is a process which should start in early adulthood.
Young adults, he says, think of retirement as something which only concerns old people. "But there's no better time to start planning than when you are young."
Middle adulthood - from about the age of 40 to 65 - is a time to rehearse for retirement, he says. This means being willing to change.
"Start making changes now. If your self-worth comes from your employment, retirement is likely to make you feel unworthy.
"Take a critical look at yourself. Review your roles and relationships. Decide which are important to you and how to establish yourself in new roles. Build friendships outside the workplace."
By the next stage, that of the mature adult (65 or older), you'll be retired, adjusting to a life without work, where health problems and death become an issue and your dependency on others increases.
As you get to grips with retirement, you'll set new goals; learn to live on a new budget; identify things which have grown unimportant and find new interests.
"Start thinking about death and dying but don't become preoccupied with it. Plan and prepare for death, then forget about it."
Keep your debt low, he says. "If you can't afford something, don't buy it. But never use money as an excuse for not doing something."