BUDGET MAKES THE RETIREMENT ANNUITY A POWERFUL SAVINGS VEHICLE
While the impact of the new budget will continue to be analysed for some time, a key implication for investors is that the retirement annuity (RA) is now even more effective as a retirement planning and savings vehicle.
Two major changes announced by the government – the introduction of a 15% withholding tax on dividends and an increase in Capital Gains Tax (CGT) from 25% to 33.3% (along with the current other benefits) have combined to make the RA a powerful savings tool.
Forget the negative publicity of the past, which made RA’s seem unattractive due to inflexibility, a lack of transparency, high administration costs and heavy penalties a lack of flexibility of meeting investors’ changing needs as to contributions. Modern RAs have largely addressed these negatives offering far greater cost effective and flexibility solutions. Equally important, the tax shelter provided by RAs is now an effective way of minimising the impact of withholding tax, the increase in CGT as well as tax on interest.
In short, the modern RA – and the linked RA specifically – is going to be a critical tool in assisting investors to meet their retirement savings goal.
Let’s firstly look at withholding tax.
Prior to the budget, many experts believed that the 10% secondary tax on companies (STC) would be offset by a new withholding tax rate of 10% – leaving investors in a fairly neutral situation. But, as we know, the rate was set at 15%.
Secondly, the unexpected surprise in the budget was to increase CGT, where the inclusion rate has moved up from 25% of an individual’s capital gains to 33.3% – effectively moving the tax on capital gains from 10% to 13.33%.
This has two implications for taxpayers:
- Anyone who saves via mechanisms such as unit trusts or share investments over a period of 20 – 25 years is now going to be taxed on their dividends at a rate of 15%. The result, obviously, is a far lower return over the long-term.
- The other implication is that, should the taxpayer decide to switch some investments into lower or higher risk assets to take advantage of market conditions, these may result in a capital gain – and CGT therefore being applied at the higher inclusion rate of 33.3%.
So it’s a double whammy, and the compound negative effect is, over a period of time, substantial.
Add the existing exception of tax on interest, the RA becomes a very powerful vehicle indeed.
The law even allows 15% of your taxable income to be placed into retirement products like your pension fund and RA, which has the effect of also lowering the individual’s tax base.
In fact from 2014 people under the age of 45 will be able to deduct 22.5%, for those older than 45 the rate will be 27.5% of taxable income from contributions to retirement products.
Annual deductions will be limited to R250 000.00 per annum (over 45 the limit is R300 000.00 per annum).
Modern RAs, sometimes called “linked RAs”, also allow the flexibility to switch into Equity, Bond or Cash funds, unit trusts or any other suitable investment at anytime. If the taxpayer believes there’s an opportunity to take some profits, that’s possible too. This provides greater flexibility to manage one’s investments over the long-term without having to worry about the tax implications of your investment decisions. The modern RA even gives you total flexibility in selecting multiple, suitable asset managers and to change them at any time without penalties.
The beauty of the RA is that this activity and profit-taking and income generation is free of any taxes. So, if you compare investing in ordinary unit trusts, versus the same investment via an RA, the compounding effect is impressive over a 20 year period and means you’re actually earning 15% more on dividends, 40% more on your interest and property income and 13.33% more on your capital gains. Therefore, over a prolonged period, an RA creates far greater retirement wealth.
Consider the following rough calculation when investing a bonus or R100 000.00, which is placed either in unit trusts or an RA. If you compare the after tax growth over a period of 20 years, the unit trusts will deliver an investment of approximately R560 000.00, versus about R1.37 million in an RA.
Yes, it sounds remarkable. But remember that in an RA there are no tax deductions, either at commencement of investment (on the original R100 000.00) or during the life of the investment – no tax on interest, dividends or capital gains. So, providing all these amounts are re-invested in the RA, the compounding effects over 20 years brings you to the figure of R1.37 million.
By contrast, the non-RA investment of the bonus immediately loses R40 000.00 tax, meaning the original after tax investment figure is only R60 000.00. Then, at each stage of the journey, dividends, CGT and interest are also taxed. The net result in a significantly reduced amount of only R560 000.00 less than 50%. The impact over 20 years of someone contributing R10 000.00 per month is even more significant.
By transferring the R1.37 million into a Linked Living Annuity (LLS’s) one can continue to protect your investments from tax while earning a far higher income in your retirement – R48 101.00 per annum vs. R25 687.00 per annum after tax and CGT on post retirement income. And the fact that RAs and LLA’s are free from estate duty as well makes the argument for RAs even more attractive.
So, in the new budget environment, the RA is a very good vehicle for saving for your retirement.