How pensioners can grow wealth and pay less tax

Question: My wife and I are in our eighties and we each have a R1.8-million investment at the bank, which gives us combined monthly interest of R24,000. We use R5,000 of this to supplement my company pension each month.

I have just done my provisional tax and I am horrified by the amount that I have to pay. Is there something we can do to reduce this tax bill?

Answer: Well done on splitting your investments between your wife and you. You have already added a layer of tax efficiency into your investments that many people forget to do.

Remember, donations between spouses do not attract donations tax, so if you have a large lump sum to invest, you can make it more tax-efficient by investing more of the money in the name of the spouse with the lower tax rate.

The appeal of fixed interest investments is that you know exactly what you are going to get. The downside is that all the growth is taxed, regardless of whether you take it out or leave it to grow. This growth is added to your income each year, so you will end up paying tax on it at your highest possible rate.

Possible solution

An alternative is to invest in an investment portfolio where you have capital growth.

When you draw an income from the portfolio, the bulk of the income will be classed as a capital drawdown and will not attract any tax.

The portion that does attract tax will attract capital gains tax, for which the rate is less than half of your normal tax rate.

Your choice of investment portfolio is very important. In the past I spoke about investing your money in three pots, but now, with the new retirement fund legislation, I’m going to have to change this to three buckets.

In the first bucket you invest enough to cover at least two years’ worth of income, as well as enough to deal with family emergencies. This bucket will be invested in the conservative portfolio, where your capital is completely preserved, as it would be with a bank deposit.

In the second bucket you would invest at least three years’ worth of income. This would be invested in a portfolio where your capital would be preserved over a five-year timeframe and target a higher level of growth than the first bucket.

In the third bucket you would invest the rest of your money in a portfolio where there’s going to be a better level of growth than in the second bucket.

By doing this, you should be able to grow your wealth while paying significantly less tax than you would have done had you left the money in a fixed-interest investment.

In order to reduce your tax bill further, you can invest up to 27.5% of your taxable income in a retirement annuity (RA).

Insider tip

The two-pot system has made investing in an RA very attractive to retired people. If you ever need access to a capital sum, you can withdraw up to one-third of the RA investment. Although you will pay tax on this amount, you will effectively be in a tax-neutral position, as you received a tax break on the contribution when you made the investment.

As many retired people made lump-sum retirement withdrawals when they retired, they could be in the situation where any future lump sums will be taxed at 36%. Now they are in the situation where they can access up to one-third of any new RA investments and be in a tax-neutral position. DM

Kenny Meiring is an independent financial adviser. Contact him on 082 856 0348 or at financialwellnesscoach.co.za. Send your questions to [email protected].

This story first appeared in our weekly Daily Maverick 168 newspaper, which is available countrywide for R35.

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