Official retirement products have great tax benefits but come with some restrictions. Understand your options before you commit.
Making the decision to start investing for retirement is the first step. The next step is to decide on what tools to use. This means figuring out the difference between retirement products and other products on offer.
The range of options to consider can leave you flattened even before you’ve made a start, but the best way to approach these options is to think about your needs and your level of self-control. Some options will give you freedom and flexibility, which may tempt you to withdraw prematurely and lose the benefits of compounding over time. Others will lock you in, but give you great tax deductions in return. Decide on what works for you from the options below.
Locked in, with tax benefits
The tax efficiency of retirement products makes them a logical choice for most people saving for retirement. In order to encourage people to invest for their retirement in pension funds, provident funds and retirement annuities (RA), government offers generous tax incentives – but with the catch that you can’t easily access the money before you retire.
In the interests of limiting investment risk, retirement products also come with limits on the percentage that can be invested in higher risk assets such as equities and offshore investments. These rules, known as Regulation 28, can stymie your growth, especially if you start saving for retirement in your 20s.
What is the difference between pension funds, provident funds and retirement annuities?
Traditionally, when you joined a company, you simply became a member of your employer’s retirement fund – usually either a pension or provident fund. But many companies are switching to retirement annuities, which offer flexibility and choice for their employees, who are the ultimate owners of their individual RAs. Some companies also offer their employees a pension or provident fund in an umbrella fund structure, which can offer cost benefits to employees.
While the rules for pension funds, provident funds and retirement annuities used to be quite different, they are now much more aligned. All three products allow you to take a maximum tax deduction on your contributions that is the greater of: 27.5% of total gross taxable income or 27.5% of total gross remuneration (subject to an annual ceiling of R350 000).
Since 1 March 2021, the options for members of these funds at retirement are also aligned: At retirement, members can withdraw up to one-third of their investment as cash. The rest must be transferred to a product that can provide them with retirement income, such as a living or guaranteed life annuity. A higher proportion may be available as cash but only if their investment is below a specified legislated amount or if a portion of their investment has vested rights. Vested rights were given to members of provident funds when the legislation governing these funds changed. Investments with vested rights can be transferred between retirement funds and can be taken up to 100% as cash at retirement.
The main difference between pension or provident funds and retirement annuities, is that in a retirement annuity, the investor owns the investment in their own right and membership is not tied to their employment status. In other words, their investment can continue, and they can keep on contributing, even if they leave their employer. Members usually cannot continue contributing to their employer’s pension or provident fund when they leave that employer.
If you want tax benefits and accessibility
There has been much debate about the benefits of tax-free investment (TFI) products compared to retirement products. Both of them grow free of dividends tax, income tax on interest and capital gains tax.
The main difference between the two products is that retirement products offer tax savings now, you pay less tax now because you make contributions with earnings on which you have not paid tax, but you will pay tax later when you draw an income, i.e. you defer paying tax. With TFI products, on the other hand, you use after-tax money to invest, but you pay no tax later; your withdrawals are completely tax-free.
You may withdraw your money at any time, which is an advantage if you prefer to have accessibility, but it could also mean that you dip into your savings and lose out on the effects of compound interest. Crucially too, you may only invest R500 000 over your lifetime and R36 000 per year, which may not be enough to fund your retirement – but you can use a TFI in conjunction with your normal retirement product to give you greater access to higher risk investments such as equities and offshore investments.
If you want no limits on your investment
For the DIY-type, investing directly into unit trusts may be an option to consider. Like TFIs your contributions are not tax-deductible but unlike the two options above, your returns will be taxed, which will reduce your returns. The benefit is freedom to invest into any assets and access your money when you choose. However, like in a TFI product, you may be tempted to withdraw and lose out in the long term.
Whichever product you choose to use make sure that you understand the rules of your product before committing to it. Changing course midway can have huge tax implications (and in some cases, there may be penalties). If you are uncomfortable doing this on your own, an independent financial adviser can help you through the options.
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