Retirement Annuities VS Tax-Free Investments
- Access to your cash
Your investments in an RA cannot be accessed before the age of 55, except in very specific circumstances.
You can access your TFI at any time. However, withdrawing from a TFI account impacts negatively on your lifetime investment limit of R500 000 – you cannot replace money that you have withdrawn.
- Tax savings
The main difference between the two products is when you get the tax benefit.
An RA offers tax savings now, i.e. you pay less tax now because you make contributions with earnings on which you have not paid tax, but you will pay tax later, i.e. you defer paying tax.
Apart from deferring tax in an RA, a further tax saving may come from paying a lower average tax rate on the benefits withdrawn from the RA at and after retirement, versus the tax saved on contributions. The first R500 000 of any lump sum you withdraw from your RA at retirement is currently tax-free, but this includes any pre-retirement withdrawals from this or any other retirement products. You can withdraw up to one-third; the rest of the benefit must be transferred to an income-providing product, such as a living annuity or a guaranteed life annuity. When you pay income tax on the benefit from your living annuity or guaranteed life annuity, you are likely to be taxed at a lower rate than when you were making contributions, which is where the potential additional tax savings come in.
With TFI products, on the other hand, you use after-tax money to invest, but you pay no tax later; your withdrawals are completely tax-free.
- Investment restrictions
RAs are governed by the retirement fund regulations, specifically Regulation 28 of the Pension Funds Act, which limits the exposure you can have to riskier asset classes, such as equities and offshore investments. In TFI products, there are no restrictions on asset classes but you can only invest in investments that charge fixed fees, which limits your selection.
- Maximum investments
While you can only invest up to 27.5% of your salary tax-free into an RA, there are no penalties for exceeding this limit. You can invest as much as you like, whenever you want.
It’s important to note that you can only invest R30 000 per year in TFI products. This is the maximum limit for all TFI accounts in your name, across product providers.
If your goal is to save for retirement, the maximum annual contribution of R30 000 in a tax-free savings account may not be enough to sustain your lifestyle, and, if you over-contribute, SARS will hit you with a hefty 40% tax penalty.
- Estate planning
You may nominate beneficiaries for an RA, although the trustees determine the allocation between your dependants and nominees. You may nominate beneficiaries when the TFI is a life policy. RAs are exempt from estate duty, whereas TFIs form part of your estate and attract duty, although there are no executor fees if beneficiaries have been nominated.
- Investing on behalf of your children
While it is technically possible to invest in an RA on behalf of your children, you will forego the tax benefit if they have little or no income to claim against. They can also only access the money once they retire.
Because TFIs grow free of capital gains tax, they are an excellent option for investing on behalf of your child as their true benefit will be felt through compounding gains over the long term. While you cannot invest more than R30 000 per year in a TFI, this restriction is per individual investor, so you are free to invest R30 000 in your own name and those of your children. However, the amount you invest on behalf of your children will reduce their own life-time contribution limit.
Remember, that if you donate money to your children or transfer an investment to them, you are liable for donations tax at a rate of 20% of the donated amount, which must be paid by the end of the month after the month the donation is made. There is an annual donations tax exemption of R100 000. This exemption is per person donating per year and not per donation made.
…RAs and TFIs fulfil different objectives and it may not be either/or decision…
Which product is right for you?
RAs and TFIs fulfil different objectives and it may not be an either/or decision, but rather a question of using both for different needs. From a retirement savings perspective, in most cases RAs offer the best tax deal. However, you need to be able to live with the restrictions described above. For long-term discretionary investments, it probably makes sense to put your first R30 000 into a TFI product. Remember, however, that you will need to be disciplined and resist the temptation of withdrawing from your TFI account in order to enjoy the long-term compounding benefits.
January 30, 2017
The Wealth Room