How to access tax-free growth on one’s retirement savings

By Rita Cool

It’s the start of a new year and you have promised yourself that this year you will be better with your personal administration. How about achieving this goal and getting some “free” money at the same time?

It is retirement annuity season, which means that you have until 28 February to check that you have contributed enough towards your retirement and tax-free products. By using the full benefits available you could get tax back but in all cases you will get tax-free growth on your investments going forward. This tax-free growth helps your investments grow over long periods thanks to compound interest.

You can use this tax-free growth in three ways:

1 Make additional contributions towards your employer retirement fund

Check if your retirement, pension or provident fund at work allows you to contribute extra before the end of the tax year. If they do, arrange that you make the additional contribution into the fund. If you know that this will be an ongoing situation, see if you can choose a higher contribution rate to the fund.

You can contribute up to or R350 000 a year or 27.5% of your taxable income and claim the tax back on that. Note that your total taxable income is not only your pensionable salary with your employer – it includes all taxable income you receive. If you want to contribute more than this, you can roll over the tax benefit to a future year, even up to your retirement, so the tax benefit is not lost. Make sure you keep records of any contributions rolling over so that you can claim them in the future. It does not matter if you make the contribution to a pension or provident fund, the tax rules are the same.

The benefit of making the contribution to your employer fund is that it is most likely the cheapest way to save for your retirement. You normally don’t pay ongoing admin fees or advice fees on assets under management, just on contributions, which should be lower than what you would pay as an individual. The ongoing investment costs are priced at discounted rates because you are part of a group instead of standard investment costs that you would pay as an individual. It is also easy to manage if all your funds are together but check that your retirement fund has the correct investment strategy for you or if you need to diversify by setting up an RA.

The disadvantage of investing extra in your employer fund is that you don’t have access to that money until you leave your employer. In some cases funds will not allow you to make additional contributions and then you can consider using an individual RA. You do not need a tax certificate for SARS if your employer makes the contribution, as it will show on your work IRP5. Your investments are governed by Regulation 28, which limits the amount you can invest in shares and offshore.

2 Make contributions towards your retirement annuity (RA)

If you work for yourself or your employer funds do not allow additional contributions, an RA is an excellent place to save for your retirement. You get the same tax benefits as contributing to a pension or provident fund.

Look for a new-generation RA if you have not set one up yet. These allow you to only pay upfront fees on contributions made and not for the whole period you are supposed to contribute. Therefore you don’t pay penalties when your situation changes, for example where your contributions have to stop when you join an employer fund. You also don’t have to specify when you are going to retire and have flexibility if you want to make additional contributions or need to stop contributions. Each year you will get a tax certificate from the service provider that you can provide to SARS so that you can get the tax back on the contributions made.

You cannot access your RA until you retire, at the earliest age 55, and at that stage you can only receive up to a third in cash, after tax. You have to use the balance to set up a monthly retirement income. You can, however, withdraw the money when you have emigrated. Your investment strategy is also governed by Regulation 28.

3 Make contributions towards your tax-free savings account (TFSA)

A TFSA allows you to save and get tax-free growth but you can also withdraw your savings if necessary in the future. You can contribute up to R36 000 each tax year towards a TFSA with a maximum of R500 000 over your lifetime. Don’t discount the smaller amounts, as they add up over time. Those who started when the product launched a few years ago are already seeing the benefit of the tax-free compounding effect.

You do not get any tax back on the contributions but there is no tax levied on interest, or on dividends or on capital gains within the product. Investment companies are not allowed to charge performance fees on TFSA investments. You can have more than one TFSA with different providers and you can now also merge different ones but you can’t contribute more than R36 000 per tax year currently. You can use a TFSA for an emergency savings account, for your child’s education account or to supplement your taxable income after retirement. That way you save even more tax in the long term. You can invest in very conservative portfolios like cash without incurring additional income tax on large amounts but you can also invest everything in shares or even in overseas portfolios if you have a longer timeframe in mind. As a parent or grandparent you can also invest in your child or grandchild’s name and then hand over the investment when the child becomes an adult. You can also use it for school or other expenses before that date.

Make sure that your contribution reaches the fund before 28 February to use all your benefits for this tax year. You can also contribute as quickly as possible in the new tax year for a full year of tax-free growth.

Even though retirement funds and RA investments are governed by Regulation 28, this is not a limiting factor for these products. Alexander Forbes analysis based on best-estimate assumptions in November 2020 has shown that tax-free growth, combined with the tax benefits on the contributions, far outweigh what could be achieved by investing more in shares or offshore. Over your working career the compounding effect can increase your income and cash at retirement by around 30%, after income tax has been taken into account. This saving can be even more for higher tax brackets.

Rita Cool is a certified financial planner at Alexander Forbes Individual Consulting

BUSINESS REPORT