If the Government pushes ahead with its plans to change the taxation structure of retirement funds the new system is likely to be based on recommendations made two years ago by the Katz Commission of Inquiry into the restructuring of the tax system.
The main principles recommended by Michael Katz - endorsed by Government - are that
all retirement funds (defined benefit and defined contribution) should be taxed on the
same basis; and that retirement funding should not be given any tax advantages over any
other type of savings.
Katz on pre-retirement
Katz has recommended that contributions, within maximums to both pension and provident
funds, be tax-deductible. Under his recommendations you would be able to deduct
contributions up to 7,5 percent of your pensionable income from your taxable income.
Your employer would be entitled to claim a further amount off tax equal to a maximum of
15 percent of your pensionable income. This means that an amount equal to 22,5 percent of
your pensionable income would not be taxed.
This formula would apply whether you are employed by the Government or the private
sector.
The build-up in value of your retirement capital would, however, be taxed.
Katz recommended that interest, rental and any trading income earned by the capital in
a retirement fund should be taxed at a flat rate of up to 30 percent.
The Government has already moved on this recommendation and in the 1996/97 Budget the
Government accepted the principle, but at a lower 17 percent. This was pushed up to 25
percent in the 1998/99 Budget, making a real impact on final benefits. The reduction of
benefits by as much as 25 percent has been estimated by the retirement industry.
Katz on retirement
All your retirement benefits should be lumped together and the full amount taxed. He
has recommended that the first R50 000 of your retirement benefits should be tax-free and
that tax incentives should be given to encourage you to buy a monthly pension with some of
your accumulated retirement funds.
These incentives are:
* Any portion taken as an annuity (regular pension payment) should be exempt from tax
up to R120 000 of your retirement capital, and;
* If you use more than R120 000 to purchase a monthly pension, then 50 percent of any
further portion is also exempt from tax up to a maximum of R210 000 of your retirement
capital.
This would give you a maximum of R380 000 of your retirement capital exempt from tax on
a lump sum of R540 000 invested in a monthly pension.
The rest of your retirement capital would be taxed on a sliding scale at marginal rates
up to a maximum of 45 percent, which would click in at R750 000 after the deduction of the
R380 000 tax-free amount. You could use all your retirement capital for a monthly pension
but you will get no tax credit beyond the R380 000.
An investment of R540 000, giving you the maximum R380 000 tax benefit, would buy you a
taxable monthly pension of R5 300,65 at current rates if you were a man aged 60. Women
would get less because they live longer.
Here are three scenarios:
Scenario
One
Not purchasing any monthly pension
Capital sum:
R1 500 000
Tax-free:
R50 000
Taxable amount:
R1 450 000
Tax on the first R750 000:
R202 500
Balance at 45%:
R315 000
Tax payable:
R517 500
Funds available for investment:
R982 000
Scenario
Two
Purchasing a monthly pension with the full
amount:
Capital sum:
R1 500 000
Tax-free:
R 380 000
Taxable amount:
R1 120 000
Tax on the first R750 000:
R202 500
Balance at 45%:
R166 500
Tax payable:
R369 000
Funds available for investment:
R1 131 000
Scenario
Three
Using R540 000 only to buy a monthly
pension:
Capital sum:
R1 500 000
Tax-free:
R 380 000
Taxable amount:
R1 120 000
Tax on the first R750 000:
R202 500
Balance at 45%:
R166 500
Tax payable:
R369 000
Funds available for investment:
R591 000
Plus annuity:
R540 000
Total:
R1 131 000
The difference between scenario two and scenario three is that in scenario three R591
000 is available to invest at your discretion. Only the R540 000 is locked into purchasing
an annuity income stream.
The discretionary funds allow you to structure more tax-effective income streams,
greater flexibility and a greater choice of investments.
(This is an extract from Retirement - The Amazing and Scary Truth by Bruce
Cameron and Magnus Heystek.)