By Nirdev Desai
When it comes to personal finance, every individual has different needs, dreams and financial goals, as well as different pathways to achieving the objectives. One of the most common long-term ambitions shared by many South Africans is to retire comfortably – to live confidently, knowing that there are enough funds available to cover your basic needs. Making regular contributions to a retirement annuity (RA) and supplementing it with a tax-free savings account (TFSA) can be an effective way of getting there.
The golden thread: cashing in on the tax benefits
RAs and TFSAs are two different financial instruments but they share one powerful advantage: tax efficiency. An important part of structuring a savings and investment portfolio for maximum returns involves choosing products that attract less tax. Making tax-efficient choices can help you save more and plan effectively for a successful financial future.
South African legislation allow individuals to deduct up to 27.5% from their taxable income (capped at R350 000 per tax year) to retirement funds, which includes retirement annuities. What this means in practice is that instead of being taxed on 100% of your yearly income or remuneration, you could be taxed on only 72.5%, if you contributed the maximum during the tax year. Moreover, growth on assets in RAs is tax-free, allowing individuals to earn interest income, dividends or capital gains from their contributions, which are exempt from tax.
The lump sum withdrawn at retirement age, however, will be taxed according to the relevant retirement lump sum tax table. Likewise, annuity income received will be taxed as normal income at your marginal income tax rate. In this context, a lump sum refers to one-time, larger withdrawal, whereas annuity income refers to regular (typically monthly) payments received from a living annuity or guaranteed annuity as a stream of income over time.
Withdrawal options: when timing matters
Likewise, a tax-free savings account (TFSA) is one of the most effective vehicles for making your money grow and maximising the tax-free portion of your investment portfolio.
South Africans are allowed to allocate up to R36 000 per tax year to a TFSA or R500 000 over the lifetime of the investor. Any amount earned or withdrawn from the products have no capital gains or income tax implications.
One of the main differences between RAs and TFSAs involves whether the investment or any returns made on the investment can be accessed and when. In the case of an RA, the lump sum as well as any returns earned can, generally, be accessed at the age of 55 or upon early retirement due to permanent disability.
In contrast, investors can withdraw from their TFSAs at any time, although it’s important to remember that if funds are withdrawn, they cannot be replaced. If investors choose to withdraw funds and reinvest them at a later date, this will count as an additional contribution towards the lifetime allowance of R500 000.
Choosing the right avenue to follow when planning for retirement, as well as the most tax-efficient financial instruments, relies on being able to make informed decisions. This is where having the help of an adviser can make all the difference – work closely with yours to align your financial plan with your goals as your life changes and evolves. Decisions made today, can have a big impact on your tomorrow.
* Desai is the head of sales at PSG Wealth.
PERSONAL FINANCE