Demystifying tax implications of retirement funds
And drawing an income one day …
Whilst we are still working and earning a monthly income, we put away money towards our retirement. This is so that, one day, we no longer have to work and can start drawing an income from our retirement savings. That is the plan, but I find that many of my clients are confused regarding how their different investments come together at retirement in order to provide them with this income.
Minding your Ps and RAs
The main retirement savings vehicles are Pension and Provident Funds, and Retirement Annuities. The main difference between these different vehicles is that the former are employer provided funds, whereas the latter are typically used by self-employed individuals, or those people who want to increase their retirement savings.
In addition to these retirement savings vehicles there are also discretionary investments such as unit trusts, shares, tax-free savings accounts, properties, which supplement your retirement savings.
In terms of the Income Tax you are allowed to contribute up to 27.5% of your income towards retirement savings vehicles (Pension and Provident Funds, and Retirement Annuities), and to obtain tax relief on these contributions. You do not receive any tax relief on contributions made to your discretionary investments.
When you reach retirement and wish to retire from your retirement fund investments, there are certain tax concessions that you are entitled to. For Pension Funds and Retirement Annuities you are entitled to take, in Cash, up to one-third of these savings. The first R500,000 of this Cash amount is tax-free, and the balance is taxed according to the following tax table:
- R500,001 – R700,000 @ 18%
- R700,001 – R1,050,000 @ 27%
- Amounts in excess of R1,050,001 @ 36%
The balance of two-thirds needs to be invested in an annuity (pension), which will pay you an income in retirement. As you were entitled to claim your contribution towards these funds as a tax deduction in the build up to retirement, when you start drawing an income from your annuity (pension), this income is taxable in your hands according to the South African Revenue Service published tax tables.
The rules for Provident Fund members are slightly different. Previously they were entitled to cash in their full Provident Fund savings, which amount would be subject to the tax tables mentioned above (first R500,000 tax free, etc.).
However legislation changed on 1 March 2016 whereby, going forward, members of Provident Funds would be subject to the same rules as those members on Pension Funds and Retirement Annuities, whereby they could only take one-third of the value of their fund in Cash, and the balance of two-thirds must be used to provide them with an annuity (pension) in retirement. There are certain exemptions to this requirement:
- Anyone over the age of 55 on 1 March 2016, who was a member of a Provident Fund, would not be subject to these new regulations
- In addition, if the fund balance of a member’s Provident Fund is less than R247,500, they will not be forced to buy an annuity with two-thirds of their Provident Fund savings.
In addition to your retirement fund savings, it is important that you also have discretionary savings which can be used to top up your monthly annuity (pension), and to pay for lump sum expenses such as holidays and new vehicles.
The plus of unit trusts
With a unit trust it is a simple matter to draw additional income or lump sums. Units in the unit trust can be sold for this purpose. It is a little more difficult to draw monthly income from a share portfolio as shares normally need to be sold in order to do this. With a property that is rented out, you will receive the rental income on a monthly basis. Where a problem may arise is when you do not have a tenant for your property, or the tenant refuses to pay and you struggle to evict them.
A Certified Financial Planner can assist you to navigate through these various decisions, and advise you on how your retirement savings should be structured, so as to take advantage of any tax concessions you may be entitled to, and ensure that you will have sufficient income in retirement.