With the end of the tax year approaching at the end of February, now is the time to ensure that you have maximised your tax benefits. Carrie Norden, senior tax specialist at Allan Gray, helps investors navigate the benefits and limitations of retirement and tax-free investment products.

While pension and provident funds are made available through an employer, either through their own fund or an umbrella, a retirement annuity (RA) is a product that investors can hold in their own personal capacity. RAs are not linked to employment and are a good mechanism for saving for retirement for those who are self-employed, or those looking to supplement their employer's arrangement.

“A retirement annuity is a great way to save for your retirement,” says Norden, mentioning a number of tax benefits, including the fact that contributions to RAs, up to a specified annual limit, are tax-deductible: “You pay no tax on interest, dividends or capital gains. In addition, when you die, a retirement annuity doesn’t form part of your estate (except for excess retirement fund contributions used on death to reduce the taxable portion of a cash lump sum taken by your beneficiaries), so there are estate duty advantages too.” 

However, there are some limitations to be aware of. “The annual tax deduction for retirement annuities is limited to 27.5% of the greater of your remuneration or taxable income, capped at R350 000 per tax year,” explains Norden. But she adds that this shouldn’t deter investors from investing over this limit, if they can afford to: “Any excess amount that you contribute will continue growing year-on-year until you utilise it. You can reap the benefits even on death, should your beneficiaries choose to take a cash lump sum.” 

The biggest drawback of RAs is that you cannot withdraw before the retirement age of 55, except in exceptional circumstances, such as ceasing to be a South African tax resident. “When you retire, you can only access up to a third of your investment in cash, unless your fund benefit does not exceed R247 500,” states Norden, “and then you have to choose an income-providing vehicle, such as a living annuity or a guaranteed life annuity.” 

Tax-free investments 

If you are already maximising your annual RA tax deductions, you may want to consider supplementing your long-term savings with a tax-free investment (TFI). “This is a discretionary product,” says Norden. “It’s not a retirement savings vehicle, but as with RAs, you don’t pay any tax on interest, dividends or capital gains – which can result in notable savings over the long term.” 

Many investors prefer TFIs because of their flexibility. “You can access your investment at any point in time,” she explains. “However, your contributions are made with post-tax money, which means they are not tax-deductible contributions. While your tax-free investment forms part of your estate, if it is structured as a life policy, the investment can be paid to your beneficiaries immediately and there are no executor fees.” 

With a tax-free investment, you can only invest R36 000 per tax year up to a lifetime limit of R500 000. “You can have more than one tax-free investment, but the limit still applies to you per tax year,” says Norden. “Any amount that you withdraw during the tax year can’t be recontributed.” She adds that investors who exceed the R36 000 limit per year will pay a tax penalty of 40% on any amount that they overcontribute. “This applies when you file your tax return, so you need to keep track of how much you’re contributing each year to your tax-free investments,” she warns. 

The right vehicle for the right objective 

In weighing up the advantages and disadvantages of RAs and TFIs, investors need to ask themselves which one is best suited to their needs. “It’s not necessarily an either/or decision, but it could be a case of using both for achieving different goals,” asserts Norden.  

Depending on your needs, objectives, and available disposable income, you could consider investing in both products to increase your tax-free benefits. “A good, independent financial adviser can help you craft a financial plan that leverages the various incentives to maximise your long-term returns,” notes Norden. “A financial adviser will also help you stay the course as you set out to achieve your long-term financial goals,” she concludes.