Tax and Your Retirement
The Weekender / Business Day, March 2007

Failure to plan is planning to fail. In retirement speak, that is exactly what has happened to most retirees who thought that they were relatively well off at the outset. This thought often vanishes about six years later.

This is a worldwide phenomenon. A recent snap poll of delegates attending a Sydney economic preview by a large accounting and auditing firm found 55 % of attendees did not have a financial plan or financial planner to assist them with wealth creation - even though 70% of attendees had more than R10m invested in retirement funds.

Still, in SA, there is certainly good news ahead for retirees.

Pensioners older than 65 who have an appropriately structured financial plan may now earn about R200,000 a couple and pay no tax (taking exempt capital gains into account). Finance Minister Trevor Manuel also announced in his budget speech on February 21 that retirement fund tax has been abolished. Good news indeed – this will reduce the stress on our retirement nest eggs.

However, most people were probably not aware of what this tax was in the first place. The effect of this announcement on your future financial planning should also be considered. Retirement fund tax was levied on interest and property rental income within retirement funds (pension funds, provident funds and retirement annuities). The rate of taxation was 9% in the 2006-07 tax year, and 18% the year before. It was as high as 25% at one stage.

You probably did not notice the effect of the tax as it was deducted within the retirement fund itself.

In terms of the Prudential Investment Guidelines legislation, at least 25% of your retirement fund should have been invested in income-bearing securities. This tax would therefore have had a significant impact on your retirement savings over time. Its abolition is thus very welcome.

Retirement funds also enjoy other favourable tax treatment. There is no capital gains tax on capital gains within a retirement fund. With recent large increases in South African asset prices, such as shares and property, taxpayers are beginning to feel the tax pinch on the sale of their non-retirement fund investments.

A portfolio switch could also trigger a capital gains tax event on a non-retirement fund investment. Although the switch might be done for sound financial planning reasons, such as portfolio rebalancing after a strong run of returns in a particular asset class, it could result in an immediate tax liability.

Processing switches within a fund can consequently be a very useful way to change your risk profile without incurring a tax charge on the capital gain.

Given the favorable tax treatment on interest-bearing assets within retirement funds, it may make sense to hold the more conservative portions of your overall portfolio within these vehicles.

The taxman will eventually tax your retirement funds when you start drawing an income from them. While a part of your retirement fund can be withdrawn on retirement (usually R120,000 of that is tax free), the balance of the capital must be used to purchase a pension or must be invested to provide an income.

Historically, the focus has been on the tax-free lump-sum. The key advantage of the living annuity has been missed in that the growth in this investment remains free of income tax and capital gains tax.

This means you pay tax only on the income you draw from the investment. Thus you are able to remain in the lower tax bands while your capital grows faster than you are spending. Currently you can draw between 5% and 20% of the fund value each year.

Because you can spread your draw in retirement over many years, you will likely find that you won’t have a tax problem on retirement. It is more likely that you will have a capital problem – all the more reason to make use of a retirement fund as soon as possible. A retirement rehearsal is definitely on the menu sooner rather than later and the tax advantages pay for the silver spoon too.

My advice to you is to engage your financial planner and ensure that your retirement plan is revisited taking into account the latest tax changes.

If you do not already have an independent, certified, fee-based financial planner, visit www.fpi.co.za to select one.

Debbie Netto-Jonker, CFP™, is founder of Netto Financial Services and was financial planner of the year in 2001.