Unlocking Tax Efficiencies: Retirement Annuities vs TFIs
The end of the tax year is approaching and you have the opportunity to take advantage of the annual tax incentives SARS has put in place to encourage South Africans to save for retirement and other long-term goals.
There are certain annual tax benefits available to you through retirement funds and tax-free investments (TFIs). You forfeit these if you don’t act each year. As we approach the end of the tax year (the end of February), it is worthwhile looking at your finances. If you have cash to spare, you should consider taking full advantage of the tax incentives.
This article has been put together to help you to understand the benefits of the products should you want to invest some of your hard-earned money so that less lands up in the hands of the taxman. The tax year-end in February means that you need to act soon if you still want to maximise your tax savings for this year.
Every year you are able to make a pre-tax contribution to your retirement funds of up to 27.5% of the higher of your taxable income or remuneration, capped at R350 000 per tax year. If you have not maximised this benefit, you can make an additional contribution to your retirement annuity (RA) in the form of a lump sum. If you are invested in your employer’s retirement fund, you can make an additional voluntary contribution (AVC), or you can start an RA in your own name.
The other annual benefit the government offers is the ability to invest R36 000 per tax year (up to a maximum of R500 000 over your lifetime) of after-tax money in a TFI and benefit from growth free of dividends tax, income tax on interest and capital gains tax.
Retirement funds and TFIs fulfil different objectives and it may not be an either/or decision, but rather a question of using both for different needs.
“There are only two certainties in life –
death and taxes.”
A famous saying attributed to Benjamin Franklin reminds us that there are only two certainties in life – death and taxes. While we have little control over the first, we can be quite strategic about the second, with many legal ways to reduce your tax bill and boost your investment account.
While you have to accept that you will have to pay tax at some point, the South African government has put numerous incentives in place to encourage us to invest for the long term, while saving on our tax bill. These incentives can be very attractive, particularly when you look at how the value compounds over time.
So whether you are looking to reduce your current tax bill and save for your retirement, or reduce any future tax on investment return, there are government-approved products to help you achieve your goals. Remember, every little bit counts when saving for the long term.
Below are the differences in benefits between a TFI or an RA:
The power of compounding
When you invest, time allows your invested money to grow and compounding makes your money work harder for you. Given a long enough period to work, compounding can dramatically multiply the value of your clients’ investments so that less of their total investment will be from contributions and more from growth.
The cliché that good things come to those who wait is especially true when it comes to compounding. One could look at both the RA and the TFI as products that are tailored towards a long-term time horizon. It would thus be a reasonable notion that the more the you invest today, the better prepared you will be for life post retirement.
The below example illustrates just how impactful starting early can be.
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, access to your money is a lot more restricted in a RA than a TFI. On the other hand, with a TFI 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.
It is important to look at your your portfolio holistically to ensure your decisions fit in with your long-term plans.
If you haven’t yet reached these annual limits, you have until the end of February to take advantage of them.