Thank you for your question.
This question always causes a lot of discussion. Tax-sensitive investors tend to oppose annuities because the income derived from them (compulsory annuity) is fully taxed. Voluntary guaranteed annuity has a high tax saving effect as a portion of the income paid each month is considered as principal repayment, and the average tax rate is significantly reduced.
I don't know if you are talking about pre-retirement pension (RA) or post-retirement pension (survival pension). Although you are referring to Rule 28 of the Regulations (which does not apply to living annuities), I believe your question relates more to living annuities. Rule 28 applies only to pre-obsolete products. My comments will therefore be more focused on living annuities, with some mention of compulsory life annuities. But let's also talk a little bit more about RA.
First of all, I would like to say that unless you have reserves, your only option is to purchase an annuity with two-thirds or more of the proceeds from your pension fund or retirement annuity.
Here you can choose between a living annuity, where you can choose your income each year as a percentage of the living annuity value at the anniversary date of your annuity, or a lifetime annuity, where you are guaranteed a lifetime income.
If you have a provident fund, you are subject to a severance tax table that increases up to 36% and are entitled to receive the full amount in cash. You can also choose to receive an annuity that is taxed monthly without receiving any cash.
Read: Survival annuity vs guaranteed annuity: Which is best?
As you rightly stated, the first R550,000 of cash commuting is tax-free, regardless of whether the income is from a provident fund, pension fund or superannuation. It is important to note that the R550,000 is aggregated across all retirement funds, not per fund. Investors often forget the amounts they received in cash when changing jobs or accessing retirement funds in the past. Past withdrawals, including partial withdrawals, count towards R550,000.
Do you invest in a pension or voluntary fund?
In my opinion, you shouldn't have to choose between a pension and discretionary investments for your retirement income. You need both for different reasons. What percentage to allocate between voluntary and mandatory depends on the situation. As mentioned earlier, the capital accumulated in a retirement fund will need to be put into some kind of compulsory pension upon retirement, so unless the retirement fund is a provident fund, the division should be decided many years before retirement. Please keep in mind that it is necessary.
My “unfortunate” recommendation is to split your funding down the middle between mandatory funds (retirement funds) and discretionary funds such as cash, unit trusts, stocks, and exchange traded funds (ETFs), creating a 50/50 split. It's about achieving. The day you retire.
Why am I suggesting this?
One of the most important financial planning strategies and goals is to optimize your taxes. It makes perfect sense to build a portfolio and invest in cash until the interest generated becomes taxable. It also makes sense to “withdraw income” by selling units (unit trusts or ETFs) or shares until your income tax is in the single digits, especially if your starting tax is above 30%.
Introducing capital gains tax (CGT) can be more tax efficient than pure income tax, such as withdrawing income from a fully taxed pension. Tax is calculated based on “total taxable income”. See the table below as an example (assuming the total investment is R30 million and the CGT base cost is 50% of the investment; the drawdown is 4% per year).
annual income | income from lliving pension | Sales unit from voluntary investment | CGT | Total tax amount | Net income | marginal tax |
1.2 million | 1.2 million | Nothing | Nothing | 391,519 | 808,481 | 33% |
1.2 million | 600,000 | 600,000 | 44,322 | 197,477 | 1,002,523 | 16% |
The numbers above are highly simplified, but in theory this simple example could reduce your income level from 4% per year to around 3%, which would increase the overall sustainability and longevity of your investment. shows that it makes a big difference. Indeed, this number would be even more impressive if all investments were voluntary. But there is a tipping point where it is absolutely reasonable to have not only discretionary funds, but also mandatory funds. For most investors, mandatory funding is required due to past contributions or past employment conditions.
Most people will eventually receive some type of annuity, so keep the following in mind when choosing a living annuity.
- Rule 28 isn't it Applies to living pensions. This effectively means you can invest 100% offshore. Some managers limit offshore exposure to 45%, but this is an institutional limit, not a regulatory limit. Whether that's the right thing to do is another discussion. In my view, probably not. There are many factors to consider, the most important of which are the level of income available, the price in the offshore market at the time of the investment, and the exchange rate at the time. Getting the return risks in the wrong order can ruin your investment.
- Life annuities are outside of your estate. This means a savings of 20% to 25% in real estate taxes on the value of your investment, depending on the size of your property.
- Earnings within a life annuity are not taxed and do not incur CGT. The voluntary fund is subject to his CGT and income tax and earns interest and rental income.
- A creditor cannot seize a life annuity. This may sound trivial, but it's important to many business owners and professionals.
- There is no reason why the yield on life annuities should be lower than the yield on discretionary investments. Investors select a living annuity investment portfolio. The poor performance is not the fault of the life annuity, but rather the choice of your investment portfolio and the level of income you withdraw.
If you mention pre-retirement funds in your question, I will briefly comment on the RA, which also applies to other retirement funds.
The RA also falls outside the scope of your estate, so there is no estate obligation. Returns within the RA are tax-free and contributions are limited to R350,000 per year and are tax deductible up to a limit of 27.5% of taxable income. This is a great benefit, even if future retirement income from these funds is taxable.
Not many people retire with the same income level as they did during their working years. This means that in retirement he may pay a higher tax rate of 20-30%, while while contributing to an RA he may benefit from a 40-45% tax deduction. To do. If he invests his 45% of his savings in self-directed investments, the total return will be unparalleled, and the longer you stick with it, the more you will earn. From a cash flow perspective, it is neutral as far as net contribution is concerned.
read:
Retirement replacement rate – how much is enough?
How much do you need to retire comfortably?
Assuming you have a maximum annual investment of R350,000, consider the following:
The above results are self-explanatory. Even if an improved return of 1% per annum could be achieved with more offshore exposure than can be achieved with a voluntary fund, the result would still favor the RA as a base investment, even with the constraints of Regulation 28.
Also keep in mind that self-directed investments are subject to CGT on portfolio adjustments and income tax on interest, real estate investment trust returns and bond yields over the life of the investment, which erodes the return on your investment. please. Last picture.
read:
series of return risks
Have you considered the impact of your retirement income and returns?
Two realities that are destroying your retirement wealth
Life annuities: Be careful as too much offshore exposure can be costly
Finally, I would like to point out the attractive interest rates that guaranteed annuities currently offer. At the moment, both compulsory and voluntary pensions offer interest rates that are unsustainable if drawn against living pensions. Guaranteing a senior citizen her 10% or higher interest rate for life is not a bad option, especially if inheritance or wealth transfer is not a priority.
I hope I have answered your question satisfactorily. If you have any further questions, please feel free to contact us.
In conclusion, the best solution is to build an investment portfolio that will give you the best results as far as profits, taxes and inheritance taxes are concerned. This solution looks different for different investors. Consult with a suitably qualified advisor to help optimize your overall portfolio.
Happy investing!