Maximizing Tax Benefits for Retirement: A Guide to Tax-Friendly Investing
Creation Wealth
Financial advisors, dedicated to helping professionals plan for retirement and achieve their financial goals.
As the new financial year begins, it is a good time to focus on optimizing your tax benefits for the year ahead, especially for retirement planning. One of the most underutilized benefits is the tax-deductible contributions made to a retirement fund, which can consist of a retirement annuity and a pension/provident fund with your company. These contributions can be deducted from your taxable income up to a maximum of 27.5% of your remuneration or taxable income, capped at R350 000 p.a. Any contributions that exceed this limit will be considered disallowed contributions, which can accumulate over time and be withdrawn tax-free up to a maximum of R550,000 at retirement. This means that if you can build up a substantial pool of disallowed contributions, the tax-free amount that you can withdraw at retirement can potentially be increased infinitely.
Once you retire, the portion of your retirement portfolio that you did not take as a cash lump sum gets converted to a life or living annuity, and the income you earn from this investment is taxed on the income tax scale. However, you can offset any portion of your disallowed contribution pool that is still available against this income, enabling you to earn a tax-free income for years.
Another way to optimize your tax benefits is to invest in a tax-free investment. You are allowed to invest up to R36,000 p.a. and R500,000 in your lifetime. Assuming you contribute at the maximum annual rate for 14 years and enjoy an average return of CPI + 6% p.a., your investment will have a value of over R1.2 million, which can grow to over R6.7 million after another 15 years. This can supplement your tax-free income earned from your living annuity.
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For short-term needs and emergency funds, you can structure a voluntary investment with a capped fund value to stay within your annual exclusions on all tax benefits. Any interest-bearing asset class (such as cash and bond exposure) will have an annual interest exemption of R23,800 p.a. (R34,800 p.a. if you are over 65). Any interest earned over and above your exemptions will be taxed at your marginal rate. On the other hand, funds allocated to growth assets (such as equity exposure) can trigger capital gains tax, which is calculated using a formula that applies the net capital gain, the inclusion rate of 40%, and your marginal rate. Each individual gets an annual capital gain exclusion of R40,000.
Finally, it is important to address estate planning by ensuring continuity within the family and using investment vehicles where beneficiaries can be nominated or a trust/company to ensure that funds do not need to move to your estate at death. Estate duty is levied at 20% and 25% depending on the value of your estate. Working with a wealth advisor to optimize the structuring of these vehicles is recommended, as it becomes quite challenging to change vehicles over time. The earlier you can start, the better the outcome as these benefits are also about time in the market.