A tax penny saved, is a pension penny earned

Death and taxes might be certain, but when it comes down to retirement savings, different tax rules might apply to different types of investments and withdrawals, and in such circumstances, it is a lot less straightforward.

Andrew Crawford, director at Seshego Consulting, says South Africa operates the attractive exempt, exempt and taxed  (EET) at the end retirement fund system. Contributions are exempt from tax through a  deduction at the retirement saver’s highest marginal rate of tax, he says. 

That means the investments that grow in the retirement fund are tax-free, unlike unit trusts and other savings vehicles, where capital gains tax and other taxes may be applicable.

When it comes time to draw down the benefit, this too can be favourable from a tax perspective. The lump-sum portion of R500,000 is free from tax, with the next R200,000 only taxed at 18%. Thereafter, the tax rates increase to 27% and 36%, respectively, but any retirement amount not taken as a lump sum and put into an annuity (pension) is also not taxed at retirement. 

The pension is taxed as income received by members, and people over 65 pay significantly lower tax rates in South Africa. “So, a big advantage in the EE phases and then with some savvy planning even the T phase can be favourable,” says Crawford.

Those over 65 receive a second tax rebate. All their medical expenses are tax-deductible (and not limited as before 65) and they can earn more interest before paying tax. 

Those over 75 receive a third tax rebate. So, by only taking a lump sum at retirement that will be taxed favourably, and then deferring the tax on the balance by putting it into a pension, the tax on the pension will also be significantly lower for over 65s.

“This is why those wanting to throw in the towel on their pensions need to think carefully. The tax regime around retirement funds is attractive and other investments, whether in South Africa or offshore, need to produce a significant outperformance to make up for the tax advantages provided to South Africans to save through a retirement fund,” Crawford adds.

Wouter Fourie,  CEO of Ascor Independent Wealth Managers, says that at this important junction in your life, a bad tax decision in retirement could cost you money, both in unnecessary expenses and by lowering the amount of money left in your pension fund to grow and look after you for the next decade or three.

While the rules vary and require the help of a seasoned tax practitioner, a rule of thumb is that retirement has its tax advantages, particularly when you reach the age of 65. You do not pay tax if you earn less than R128,650, and when you reach age 70 the tax-exempt amount is even bigger at R143,850. In addition, you can earn R34,500 in interest tax-free.

Fourie says not all payouts were created equal: The tax deductions vary between severance payouts, pension withdrawals, long-service awards, accumulated leave and many other forms of end-of-career payments. It will be in your interest to understand which of these forms of payments attract no tax, or the least tax, and structure your payouts accordingly, he says.

“Remember that you will not be taxed in the same way when you are retired as when you were still working. You should keep this in mind, as a payment or withdrawal deferred until after you retire may be taxed at a lower rate than when you were still employed.”

A certified financial planner will be able to calculate different scenarios and help you decide. Could you be making more money by keeping your money invested, or would you be in a better position to pay off your credit card debt? These decisions will vary from person to person, based on your goals, life stage and the size of your pension savings. DM/BM