Retirement: The best investment money can buy!

“Article from Moneyweb”

The investment growth at a rate better than inflation, combined with the added tax benefits, make retirement funds the best investment you will ever make.

Investments are critical to the lifestyles and well-being of most of us, but we often find ourselves lost and confused. One of the reasons for this is that the financial services industry has sown confusion with a vast array of investment products that are frequently sold indiscriminately.

Imagine an investment:

  • Where the contributions to the investment are tax-deductible* and on retirement, you can withdraw the first R500 000 tax-free*.
  • Where no tax is paid on the growth obtained on the underlying funds in the investment.
  • Where the investment does not form part of your estate and no estate duty tax is payable (savings of least 20%) and no executor’s fees (3.5% plus VAT) is levied on the investment or the growth on the investment; and
  • Where the investment and investment returns are protected from your creditors.

Best of all is that all of this is guaranteed! *

*Subject to Income Tax Act

This investment is an investment in retirement funds. These investments in pension funds, provident funds and retirement annuities are, once you strip away the marketing clutter, the best investment your money can buy!

From March 1, 2016, the total contributions to retirement funds (pension, provident and retirement annuity) are tax-deductible to a maximum of 27.5% of the greater of remuneration or taxable income, capped at an annual limit of R350 000. The taxable income used in these calculations excludes lump sums. Any excess not utilised in calculating the deductible amount may be carried forward to the following tax year.

This means that for every R1 you invest for your retirement, Sars will allow as a deduction an amount equal to your current marginal tax rate, which is between 18% and 45%.

This is best explained by an example: If your marginal tax rate is 30%, you will receive 30c as a deduction from Sars for every R1 you invest for yourself in your retirement fund. That means you only pay 70c for every R1 invested for your retirement. This is an effective return on investment of 42.85% (30/70 = 42.85%) guaranteed. This means that the higher your marginal tax rate is, the bigger your guaranteed return will be.

The table below shows the investment return obtained by the tax benefit at contribution.

Marginal Tax rate
Guaranteed Investment Return

Remember that your retirement fund (pension, provident and retirement annuity) is the “vehicle” used to obtain the tax benefit. You can benefit even more when you choose an appropriate “engine” that will provide the investment returns. A well-diversified balanced portfolio will, over the long term, provide inflation-beating returns. Thus, growth at a rate better than inflation, combined with the added tax benefits, makes this possibly the best investment you will ever make. Yes, even better than paying money into a house bond or settling debt.

R500 000 tax free

A very important factor to consider is that at retirement, which per current tax legislation is 55 and older, you will qualify to receive the first R500 000 of your retirement fund contributions tax-free (assuming you have not utilised this benefit previously). So, during your pre-retirement years, your contributions were tax-deductible but at retirement, you receive R500 000 tax-free. The tax saving on this R500 000 tax-free portion is thus a permanent saving.

Lower income tax rate after retirement

Most people earn and pay tax at their highest rate immediately prior to retirement. Most people will earn less taxable income after retirement than when they received a monthly salary. The lower monthly taxable pension income combined with the larger tax rebates after 65 and 75, will result in you paying a lower average tax rate after retirement. Thus, while you contribute towards retirement you save tax at a higher tax rate, and when you retire you pay tax at a lower tax rate. In effect, this difference is an added guaranteed return on tax savings after retirement you get by using a retirement savings vehicle (pension, provident and retirement annuity). This is besides the other advantages already mentioned (no estate duty tax, no executors’ fees, protection against creditors etc.).

To explain this, I will use a simple practical example. If you earn R50 000 per month your average tax rate, after rebates, is 23.79%. When you retire at age 65 you get the first R500 000 tax-free. That is a guaranteed return on investment on the first R500 000 of 23.79%.

If you have saved enough for retirement and are able to receive a 70% replacement ratio (70% of your last salary) your average tax rate reduces to 17.07% resulting in a permanent tax saving of at least 5.28% (tax saved when contributing at 23.79% versus tax paid on income during retirement at 17.07%) and it gets even better for money withdrawn from your pension after age 75, being a permanent saving of 5.97%.

Even if your investment growth ends up being zero for the full term, which is unlikely, then the tax benefit alone makes it a “no brainer”. To get the most benefit, you must use the full tax-deductible contribution to your retirement funds. This will also assist in providing you with an income at retirement. This practice is often referred to as “paying yourself first”.

It is never too late to start investing in your own retirement fund. February 28 marks the deadline for “topping up” your retirement funds for this tax year. Don’t miss out on this opportunity!

“The greatest risk in investments is your own behaviour” – Warren Buffet.