Opportunities or individuals to reduce their tax after retirement through the multi-billion rand flexible annuity industry have been limited by the taxman.
In a recent directive the South African Revenue Service has told the extremely successful, but comparatively new, "compulsory purchased, flexible annuity" business that it will have to limit the offers made to investors that enable individuals to reduce their tax liability.
The products, which are linked to unit trusts, could be purchased with the two thirds portion of a maturing retirement annuity which by law had to be invested in an annuity (monthly pension).
The product, in simple terms, works like this: You invest in a retirement annuity. When you retire two thirds of the money (by law) must be used to purchase an annuity (a monthly pension). But unlike other annuities you can decide on the level of the income you want. When you die, your beneficiaries will in turn receive income from the fund. In fact, it can continue into perpetuity.
Tiny Carroll, Old Mutual senior legal analyst, said the product works essentially like a trust fund but without the costs involved in setting up a normal trust.
The flexibility of the product enabled people to alter not only their income but also their tax commitments and to overcome estate duty on the capital on death.
Companies have been allowing individuals to take a return based on one to 40 percent of the value of the fund.
The taxman has now ruled that individuals must take between five and 20 percent of the value of the fund. The value of the capital grows and shrinks according to its investment performance every year.
If the value of the fund in which the retirement annuity proceeds are invested in a particular year increases then the annuity (monthly pension) must also be increased by between five and 20 percent of the improved value in the following year. The reverse holds true if the fund loses value.
Carroll said that by taking as little as one percent, particularly in the first few years of retirement, when individuals may not need as much money and may have high tax commitments, they reduced their tax commitment. In other words the capital could grow in value in the fund by deferring both income from the fund and consequently the tax on the income.
By taking a large monthly pension individuals could also effectively get around provisions of the Income Tax Act which states that a compulsory annuity must be taken for life. However, by taking 40 percent of the value each year the fund could be "bled dry" within four or five years. Although tax would be paid on the higher monthly pension payments the income could be transferred to an investment medium where the future returns and growth would not be taxed.
Carroll said while the tax directive closed some loopholes, flexible annuities remained an effective means of investing retirement capital.